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Review of Quantitative Finance and Accounting

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11-10-2023 | Original Research

Board diversity of industry expertise: impacts on strategic change and product markets

Author: Yang Fan

Published in: Review of Quantitative Finance and Accounting | Issue 2/2024

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Abstract

We provide evidence that board diversity of industry expertise leads to internal strategic change at the firm level. We base our diversity of expertise measure on the extent to which corporate director industry backgrounds vary from each. We find that greater diversity of expertise can lead to strategic change, as well as more differentiated products. However, we also find that the benefits from board diversity is moderated by the CEO’s own background. Firms with CEOs that have more general managerial abilities, benefit less from board diversity while CEOs with more specialized abilities, benefit more from board diversity.

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http://investors.3m.com/news/press-release-details/2016/3M-Elects-Two-New-Members-to-Board-of-Directors/default.aspx

For example, Apple’s 2018 Proxy Statement describes it’s directors as having “the skills, qualities, attributes, and experience...to provide Apple with business acumen and a diverse range of perspectives to engage each other and management to effectively address Apple’s evolving needs and represent the best interests of Apple’s shareholders.”

Additional studies that used unexpected director deaths as exogenous shocks include (Borokhovich et al. 2014), which examined the incentives of grey directors using executive deaths as exogenous shocks to firm values. Salas (2010) measured executive entrenchment through exogenous shocks to stock prices dues to unexpected executive deaths, and Bennedsen et al. (2007) used deaths of family members of CEOs as exogenous shocks to CEO focus to evaluate the value that a CEO brings to the firm.

For example, the Securities and Exchange Commission press release 34–48,745, November 4, 2003, notes that NYSE rules were amended to require listing firms to have a majority of independent directors and that audit committee members had to have at least one member who had accounting or related financial management expertise.

We focus on the S &P 1500 index of firms due to BoardEX’s detailed coverage of these public firms beginning in 2003. Limiting our analysis to the S &P 1500 index of firms ensures that the firms maintain full coverage by BoardEX and that our results may still be valid for a variety of sized firms, though the smallest firms in our sample still have asset values that exceed $34 million (Table 2). By our analysis, 91% of S &P 1500 firms are fully covered by BoardEX, with coverage increasing to 97% by 2005.

See the Appendix for a more detailed discussion on the mapping of the director’s employment history to their industry expertise vector.

Using the Fama-French Industry classification (as opposed to a four-digit SIC) has some drawbacks that are worth discussing. A coarser industry classification can lead to greater overlapping of industry expertise, implying greater similarity in industry expertise background This should downwards bias the impact of diversity in expertise amongst the directors and boards. The main benefit of using the Fama-French industry classification is that it allows us to more easily incorporate non-public firm employers of directors. A more thorough discussion of the construction of these industry expertise vectors is available in the appendix.

New incoming directors (“extensive margin") represents only one of the ways in which a board can diversify its advising resources. We also consider changes to the “intensive margin" in the robustness section. Boards gaining expertise at the “intensive margin" refers to incumbent directors gaining expertise through external board positions.

Director deaths as an exogenous shock to the board has been fairly well established in the literature. More recently, Fracassi (2017) and Fracassi and Tate (2012) use director deaths to examine social ties on boards. Borokhovich et al. (2014) uses director deaths to examine changes in firm value. Finally, Salas (2010) measures executive entrenchment while Bennedsen et al. (2007) uses deaths of family members of CEOs as shocks to CEO focus.

The majority of firms have CEO succession plans in place in the event of an unexpected CEO departure, but less than 14% have a similar detailed succession plan in place for directors (According to a KPMG survey https://assets.kpmg/content/dam/kpmg/cn/pdf/en/2016/09/kpmg-aci-global-pulse-survey.pdf). Vacant seats are generally left open until the next annual meeting.

For a death to be classified as unexpected, we excluded all death events in which directors went on leave before death or information was released regarding the illness of a director.

This is sometimes referred to the “zero first-stage check" that follows Angrist and Krueger (1994) and Angrist and Pischke (2009)

See Appendix for a more detailed discussion on how this measure is constructed.

Since Aug 25, 2010, new measures adopted by the SEC require proxy materials to include director nominations of long-term shareholders.

According to FactSet’s SharkRepellent, there has been a four-fold increase in the number of attempted proxy campaigns between 2010–2013 (253).

This is comparable to Nguyen and Nielsen (2010) who find a $-$0.85$\%$ abnormal return from an independent director’s death.

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Title: Board diversity of industry expertise: impacts on strategic change and product markets
Author: Yang Fan
Publication date: 11-10-2023
Publisher: Springer US
Published in: Review of Quantitative Finance and Accounting / Issue 2/2024
Print ISSN: 0924-865X
Electronic ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-023-01206-8

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