Multiple board appointments and firm performance in emerging economies: Evidence from India

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Abstract

This paper extends the literature on multiple directorships, busy directors and firm performance by providing evidence from an emerging economy, India, where the incidence of multiple directorships is high. Using a sample of 500 large firms and a measure of “busyness” that is more general in its applicability, we find multiple directorships by independent directors to correlate positively with firm value. Independent directors with multiple positions are also found to attend more board meetings and are more likely to be present in a company's annual general meeting. These findings are largely in contrast to the existing evidence from the US studies and lend support to the “quality hypothesis” that busy outside directors are likely to be better directors, and the “resource dependency hypothesis” that multiple directors may be better networked thereby helping the company to establish more linkages with its external environment. Multiple directorships by inside directors are, however, negatively related to firm performance. Our results suggest that the institutional specificities of emerging economies like India could work in favor of sustaining high levels of multiple directorships for independent directors without necessarily impairing the quality of corporate governance.

Introduction

The number of positions that directors can accept on company boards has been a contentious corporate governance issue in countries around the world. According to the “busyness hypothesis” (Ferris et al., 2003) a large number of appointments can make directors over-committed and thereby compromise on their ability to monitor company management effectively on behalf of the shareholders. This in turn could adversely affect firm value. On the other hand, in the presence of a well functioning market for outside directors, the number of multiple directorships may proxy for higher director quality (Fama, 1980, Fama and Jensen, 1983). Additionally, directors with multiple appointments, by virtue of being more networked, can generate benefits by helping to bring in needed resources, suppliers, and customers to a company (Pfeffer, 1972, Mizruchi and Stearns, 1994, Booth and Deli, 1995). Thus, having directors with multiple appointments on a board can lead to an increase in firm value.

Existing empirical evidence mirrors the differing theoretical opinion on the “busyness hypothesis”. Some studies find that multiple directorships adversely affect firm performance, lower the sensitivity of CEO turnover, manifest in a positive market reaction following the departure of a busy director (Fich and Shivdasani, 2006), lead to excess remuneration of CEOs (Core et al., 1999, Shivdasani and Yermack, 1999), and increase the probability of committing accounting fraud (Beasley, 1996). Other studies however, report that directors with multiple appointments serve shareholder interests by positively impacting firm performance (Miwa and Ramseyer, 2000), benefiting shareholders through offering them larger premiums in tender offers (Cotter et al., 1997), and generating superior returns from acquisitions (Brown and Maloney, 1999, Harris and Shimizu, 2004). Finally, selected evidence suggests that multiple directorships do not have any significant negative effect on firm value, nor do such directorships lead to directors shirking their responsibilities to serve on board committees or to be associated with greater likelihood of securities fraud litigation (Ferris et al., 2003). However, most of the theoretical arguments and the limited evidence that exists on the costs and benefits of multiple directorships are restricted predominantly to developed countries, specifically to the US and very little is known for other economies.

The objective of this paper is to contribute to the existing literature on multiple directorships by providing additional evidence on the “busyness hypothesis,” but with respect to an emerging economy, India. The choice of an emerging economy is dictated by two considerations. First, an emerging economy provides a more appropriate laboratory for analyzing the issue of multiple directorships. In developed economies like the US, where institutional investor organizations have had a relatively long history of actively seeking to limit the number of multiple directorships, companies may be compelled to employ directors with multiple positions that closely conform to recommended standards. Further directors themselves may share the view that serving on too many boards may not be feasible and therefore may voluntarily seek to limit the number of board membership that they accept (Korn/Ferry International, 1998). Under such circumstances, the incidence of multiple directorships is likely to be endogenously and nearly optimally determined so that cross-section data may not reveal much variation both within and across company boards. This in turn would make it difficult to detect empirically any relationship between busyness and firm performance (Demsetz and Lehn, 1985, Dahya and McConnell, 2003).1 Second, while systematic evidence on the relation between multiple directorships and firm value is missing for emerging economies, the incidence of such directorships in these economies is much higher compared to countries like the US.2 Further, recommended limits on multiple directorships in several of the emerging economies are significantly higher than the best practices that are in vogue in many of the developed countries. While in the US, less than three multiple directorships is often considered best practice, the existing limits in countries like India, Malaysia and Pakistan are much higher, ranging between ten and twenty.

The higher permissible limits on multiple directorships that prevail in emerging economies could be driven by supply constraints in the managerial labor market. In addition, institutional specificities in these economies could work in favor of sustaining high levels of multiple directorships without necessarily impairing the quality of corporate governance. In emerging economies like India, where companies are small and relatively few of them are transnational in nature, the level at which over-commitment sets in may be much higher than in developed countries where companies are much bigger in size with many of them having complex operations cutting across nations. The Principles of Corporate Governance issued by the Business Round Table (BRT, 2002) recognizes that the complexity of a corporation, and its operations determine the “appropriate” number of hours that a director has to spend on his/her duties. Further, in emerging economies, where family owned business groups typically dominate the corporate landscape, multiple directorial positions could be largely group-specific, based on kinship, social and family ties, that in turn could create synergies between different directorial responsibilities, both for executive and outside directors (Kang and Shivdasani, 1995, Brown, 1998, Khanna and Rivkin, 2001). Finally, in uncertain environments like those typically endemic in emerging economies, corporations may use directorial interlocks to obtain better coordination with other organizations to reduce uncertainty (Burt, 1983, Au et al., 2000), so that there could be substantial benefits from multiple directorships. Consequently, the level of directorships at which busyness sets in could be substantially higher in emerging economies vis-à-vis that in developed countries.

Using a sample of 500 large Indian companies for the year 2002–03, we estimate two relationships. First, we estimate the relationship between multiple directorships by both inside and outside directors and company performance with special focus on whether business group affiliation matters in this relationship. Second, and related to the first, we investigate whether multiple directorships over-commits a director and hampers his/her ability to discharge important directorial duties like attending annual general meetings. Using a piece-wise linear specification for our regressions, our estimations reveal that multiple directorships by independent directors correlate positively with market-to-book ratio once such directorships cross a particular threshold of three. Below the threshold we do not find any significant relation between multiple directorships and market-to-book ratio. These results are in direct contrast to findings of several studies on the US that find the absence of a relationship (Ferris et al., 2003) or a negative relationship (Fich and Shivdasani, 2006) between multiple directorships and company performance. However, while our results with respect to independent directors do not corroborate the “busyness hypothesis,” those with respect to inside directors, do. We find multiple directorships by inside directors to correlate negatively with firm performance. Our findings for the different types of directors are robust to alternative measures of firm performance based on accounting indicators like return on assets and net-value-added to assets.

When we allow the effect of multiple directorships of independent directors on firm performance to differ between group-affiliated and non-affiliated companies, we find the positive relation to persist for the latter while this effect disappears for the former. This in turn suggests that while the market interprets the incidence of multiple directorships in non-affiliated companies as a signal of directorial quality, it discounts the quality as well as possible synergistic effects that may stem from the essentially group-centric multiple positions held by independent directors in group-affiliates. In either case, however, we are unable to detect any negative effect of multiple directorships by independent directors on firm value. In contrast, multiple directorships by inside directors are found to correlate negatively with firm performance irrespective of the ownership status of companies. Finally, our analysis of board meetings and annual general meeting (AGM) attendance do not detect any evidence of shirking by multiple directors as could manifest in an absence from important company activities. In fact, the evidence suggests quite the contrary; directors with multiple board memberships are found to be more participative in the management of the company vis-à-vis their less busy counterparts.

The rest of the paper is organized as follows. Section 2 outlines the institutional context governing the evolution of multiple directorships in India. Section 3 describes the data and sample used in the analysis and documents the incidence of multiple directorships in the India. Section 4 reports the results of the empirical analysis and Section 5 discusses the group effects. Section 6 contains the analysis for board meetings and AGM attendance and Section 7 concludes the paper.

Section snippets

Multiple directorships in India: the institutional context

The phenomenon of multiple directorships in India can be traced back to the early stages of its corporate sector development. Multiple directorships evolved in India largely due to the dearth of industrial leadership with adequate experience to serve on company boards, and the institution of the Managing Agency System under which managing agents who floated new companies sought to control the management by being present on company boards. In 1949, individual directors held as many as 50

Data and sample

The data for our analysis is obtained from the Prowess database created by the Center for Monitoring the Indian economy (CMIE) and pertains to the financial year 2003.4 The Prowess database has formed the basis of several published empirical studies on the Indian corporate sector (see for example, Bertrand et al., 2002, Khanna and

Empirical methodology

We analyze the relationship between firm performance and board busyness by estimating a spline regression. Spline is a commonly used technique in empirical analysis to estimate a piece-wise relation between two variables that allows the slope of the relation to change at specific points known as spline knots or spline nodes.11

The inner circle

Till now our results have been obtained by treating group-affiliated companies symmetrically with non-affiliated companies. However, multiple directorships of directors in group-affiliated companies could be due to their multiple positions in companies belonging to a single group. In particular, inside directors belonging to founding families (promoter directors) are likely to sit on the boards of other group-affiliates with the purpose of collective coordination and overall supervision and

Multiple directorships and board meeting attendance

In this section we provide additional evidence on the “busyness hypothesis” by examining if multiple directorships over-commit directors and hamper their ability to discharge important directorial duties. As Lipton and Lorsch (1992) remark, the most commonly shared problem faced by directors is lack of sufficient time to discharge their professional responsibilities, and thereby compromise on their decision making quality and ability to provide useful advice.

One of the manifestations of

Conclusions

In this paper we have examined the effect of multiple directorships on company performance in an emerging economy. Our results do not support the concern that multiple directorships by independent directors necessarily compromise on their ability to effectively monitor companies in the interest of shareholders. Instead, our results support the hypothesis that such directors could be better directors and provide higher oversight. The results seem to be consistent with the quality hypothesis that

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    We would like to thank Ghon Rhee (editor), an anonymous referee, and the participants of the Inaugural Asia-Pacific Corporate Governance Conference (APCGC), organized by the Hong Kong Baptist University, in Hong Kong during August 2005. The usual disclaimer applies.

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