The effect of board members’ education and experience on the financial performance of German state-owned enterprises

Corporate governance refers to the structure and underlying processes for monitoring the direction and management of a company in order to ensure that the company’s objectives are achieved in the most effective manner. This does not only apply to companies in the private sector, but also to state-owned enterprises (SOEs). In this sense, the governance of SOEs is of particular importance to governments and society and follows the objective of ensuring the enterprises’ efficiency and effectiveness in the fulfilment of their (public) tasks.

The supervisory board plays a central role for corporate governance. Supervisory board members are responsible for e.g. monitoring the management or voting on decisions of high importance. They also serve as source of advice and counsel for the management. In Germany, politicians often have supervisory board control over SOEs.¹ This practice is intended to ensure the democratic legitimacy of SOEs—politicians act as citizens’ representatives and exert direct influence over the enterprise (Papenfuß, 2013b). There are, however, increasing indications that these members do not have the necessary qualifications and competencies to fulfill their mandate (Hau & Thum, 2009; Klimke-Stripf & Morner, 2018; König & Wruuck, 2011; Weiblein, 2011). Thus, democratic legitimization must not compromise the main functions of the supervisory board: namely, to assist the board in an advisory capacity and to control its actions.

Tremml et al. (2021) examine the impact of board behavior in state-owned energy companies and find that public ownership structure negatively influences the strategic control of the supervisory board. Similarly, Klimke-Stripf and Morner (2018) find in interviews with CEOs, supervisory board members, and municipal employees that candidates’ professional competence is less important than their political commitment and affiliation during the selection process. It is not that competence is seen as unimportant, but parliamentary groups do not always have suitable candidates who can bring the necessary skills to the table.

While state organizations do not primarily look for professional expertise when filling supervisory board mandates, it remains unclear what effects this structure has on SOEs. With the exception of financial institutions, there is no analysis in the academic literature known to the authors on whether this special political connectedness in the supervisory boards of SOEs exerts an influence on them. This paper therefore addresses this gap in the literature by examining the research question of whether the business competence of supervisory board members of SOEs has an effect on their financial performance. More specifically, the study aims to identify possible competence differences between politicians and non-politicians serving on supervisory members, to analyze their impact on SOEs and whether other competence-based performance influences exist. Some related studies can be found in corporate governance research, which—following the financial crisis—has increasingly focused on the role of supervisory boards as control bodies in financial institutions (Fernandes et al., 2018). Researchers have indicated that banks whose supervisory boards have less financial experience suffered greater losses during the crisis (Fernandes et al., 2016; Francis et al., 2012; Hau & Thum, 2009). Moreover, a lack of professional competence can increasingly be observed in state-owned banks. For example, Hau and Thum (2009) find that supervisory board members of German state-owned banks had comparatively less management and industry experience, with the latter having a particularly negative impact on their financial performance during the crisis.

These results underline the need to examine current staffing practices at German SOEs. Since financial institutions have unique characteristics that can be transferred to companies from different sectors only to a limited extent, it is necessary to look at other areas of general interest. Therefore, this paper addresses what influence the competence of supervisory board members has on the financial performance of state-owned utility companies.

Methodologically, we follow the research design of Hau and Thum (2009) and examine the biographical background of 3350 supervisory board members of 58 state-owned utility companies in Germany from 2011 to 2016. To obtain a measure of monitoring potential for supervisory boards, eight different biographical criteria are defined and used as proxies for boardroom competence. The variables capture board members’ (1) educational attainment as well as their (2) management and (3) industry experience. Company performance is quantified by three different profitability indicators: return-on-assets (ROA), return-on-equity (ROE), and profit per employee. Additionally, to ensure a comparable performance measurement and justify the nature of state-owned enterprises, the business areas in which the analyzed utility companies operate are identified and controlled for in the regression analysis.²

In the context of this study, we expect a positive relationship between the competence of supervisory board members in utility enterprises and their performance. However, the results of the regression analysis cannot confirm this assumption, as no significant effects of the competence variables on firm performance can be found. Yet, several models show significant negative effects of the variable management experience on firm performance when industry experience is taken into account simultaneously. In conclusion, a high share of supervisory board members with management experience but without experience from the relevant industry seem to have a particularly negative influence on the company’s performance.

The study contributes to the field of public corporate governance research by, firstly, filling existing gaps in the literature on the functioning of SOEs taking into account their specific institutional setting within the political sphere. Secondly, findings on this matter so far exist mainly for financial institutions. In this study, this is extended to companies operating in the field of energy supply, which is a typical task of SOEs in the context of providing services of general interest. Thirdly, we expand the quantitative research in this area by strengthening the understanding of how relevant business competencies are distributed among politically connected and non-political board members and whether they exert any influence on the SOEs’ financial performance. By this, we broaden the current understanding of competency and skills-based corporate governance research.

Practitioners are made aware of the impact and role of supervisory boards on state-owned enterprises. In particular, they gain insights on the importance of competencies that need to be taken into account when appointing members to supervisory boards.

For this purpose, Sect. 2 gives an overview of the relevant literature and deals specifically with the three dimensions of education, management experience, and industry experience in more detail in order to develop the literature-based hypotheses. Section 3 starts with a discussion of the particularities of state-owned enterprises in Germany, highlights the impact of this institutional structure from the perspective of principal-agent theory and describes the study design, the data, and the estimation strategy. Section 4 presents and examines the results of the panel regression, and Sect. 5 concludes.

To date, numerous empirical studies address the importance of board competence and examine its influence on company performance. In most cases, researchers examine the importance of education, experience, or tenure of board members on company performance. An instructive overview is provided by Johnson et al. (2013).

Hau and Thum (2009) published an empirical study in which they addressed the systematic underperformance of German state-owned banks during the financial crisis between 2007 and 2008. Of the 29 largest German banks, state-owned banks recorded asset write-downs and losses that were on average three times as large as those of private-owned banks. At the same time, an examination of the biographical backgrounds of 592 supervisory board members reveals a significant and qualitatively large difference in boardroom competence. Supervisory boards of state-owned banks have lower qualifications in relevant education and less management and industry-related experience, the latter causing a particularly negative impact on bank performance. The authors examined this correlation in more detail using various regression analyses and concluded that the lack of competent board monitoring is a leading explanation for the underperformance of German state-owned banks during the crisis.

Since then, an increasing number of studies have specifically addressed the issue of supervisory board member competencies in the financial industry. In their analysis of 72 publicly listed European banks Fernandes et al. (2016) find that banks with more independent and busy boards had poorer stock returns during the financial crisis and that banks with more board members with industry-related (i.e. financial) experience performed better. In a related literature review, Fernandes et al. (2018) emphasize that board experience and industry-related (financial) expertise are found to be positively correlated determinants for bank performance. Although corporate boards with less experience overall may not have triggered the crisis directly, the practices of corporate boards appear to have influenced the extent to which firms were vulnerable to the crash (Francis et al., 2012).

In the context of these studies, financial institutions under majoritarian public-sector ownership were more specifically addressed. Importantly, it has been demonstrated that a lack of competencies in the supervisory bodies is even more of a problem for state-owned banks than private ones. König and Wruuck (2011) also reveal that the high losses of some German state-owned banks in the wake of the financial crisis can be attributed to poor supervision. Here, the authors refer to an increasing fragmentation of interests: the participation of a larger number of actors with different interests and incentive structures, e.g., politicians, leads to more difficult decision-making processes—up to complete blockades within committees—and hinders effective management control.³ A similar conclusion is drawn by Andres et al. (2021), who find a negative impact of board politicization on the performance of Spanish savings banks (cajas). Moreover, they observe that political directors with financial expertise do not use their industry knowledge to benefit the banks, whereas their homologs without political connections do.

Besides financial institutions, only a few studies address the role of competence concerning the supervisory boards of SOEs. In one study, Shawtari et al. (2017) examine listed state-owned enterprises in Malaysia, where the government is actively involved. Applying quantile regression estimations for a sample of 169 firm-year observations between 2002 and 2011, the authors conclude that audit committee expertise is negatively related to the performance of the largest decile firms. For the remaining 90%, the authors find no significant results. Menozzi et al. (2012) focus on the influence of politicians on boards of directors among 114 Italian local public utilities between 1994 and 2004. Based on information on 1.630 board members, the authors find that a higher share of politicians on a board harms firm performance.

As mentioned above, there are studies that address board competence—albeit not as a main focus, but as one variable among others. In these cases, the quantification of board competence is typically kept simple. Peni (2014), for example, approximates the degree of experience by the number of years an executive has worked in the same position. In a study on financial expertise, Shawtari et al. (2017) model board competence as a dummy variable that is equal to 1 if at least one member of the audit committee is a financial expert. If focus is to be laid on the topics and content of board member experience instead, a detailed survey that includes research into board members’ respective biographies is necessary. Unfortunately, data sets of surveys in this field of research are relatively scarce. Güner et al. (2008) analyze the impact of board members’ financial expertise for a data set of 282 companies over 14 years and find that this competence has a significant effect on corporate decisions—but only in the context of the presence of conflicts of interest. Pereira and Filipe (2018) examine the educational qualifications of board members and whether they affect the performance of 25 Portuguese banks between 2012 and 2014. The authors use three indices as proxies for the educational qualifications and test their influence on the banks’ return on average assets and return on average equity. The results show that board members who hold degrees, especially from prestigious foreign business schools, have a significantly positive impact on firm performance. Volonté and Gantenbein (2016) analyze the relationship between board members' human capital, consisting of international experience, industry know-how, CEO experience and financial know-how, and firm performance—as measured by Tobin’s Q—for a sample of 560 firm-year observations in Switzerland for the years 2005, 2007 and 2009. The authors find empirical evidence for an influence of different human capital categories conditional on corporate strategy: industrial know-how has a negative significant impact on firm performance in diversified firms, while international experience is positively associated with increasing levels of internationalization. CEO experience, on the other hand, is negatively related to firm performance in internationalized firms.

In the following, we adopt Hau and Thum’s (2009) methodological approach to measuring competence, as they apply a broad definition structured into three categories. Correspondingly, we use the dimensions education, management experience, and industry experience to quantify board competence and examine the significance for company performance.

This study investigated how the business competence of supervisory board members impacts the financial performance of state-owned utility companies. This question is particularly relevant for SOEs, as their supervisory board members are often politicians—as representatives of the public owner(s)—instead of external members. For example, our data shows that 75% of the supervisory board members hold or have held a political mandate.

The competence of the board members was mapped via the three dimensions: education, management, and industry experience, and was ascertained by researching biographical information. We reveal that politically connected board members score worse in all three dimensions—especially in industry experience. However, regression analyses in this study do not show negative effects on the companies’ profitability that can be attributed to a lack of competence which might be based upon supervisory boards’ less decisive power due to the political connectedness of SOEs.

We explored the assumption that board members with previous management experience from other industries rely too much on knowledge that is not transferable to the industry-specifics of the energy sector. Indeed, the data shows that a higher proportion of managers without industry experience has a significant negative effect on two of the three analyzed profitability indicators (return-on-assets and return-on-equity), which might be based on the existence of a harmful overconfidence bias.

Our definition of competence is based on a formalized form in terms of business competence. However, SOEs do not necessarily pursue exclusively economic goals, but also public service goals. Moreover, they potentially have a wider range of primary stakeholders. Therefore, it seems feasible that other or additional forms of competencies are relevant for the achievement of these goals and that these competencies are primarily held by politicians and/or require political experience. In this respect, the focus on 'classic' board competencies, which are also applied in comparable studies focusing on the private sector, is a limitation of the study. A second limitation concerns the dependent variables under investigation. As described above, SOEs do not necessarily pursue only economic objectives. Depending on the company and, if applicable, the sector to which it belongs, public service objectives can also form a significant part of the company's orientation. Accordingly, an investigation of the effects of board competence on only financial or economic indicators such as ROA, ROE or profit per employee is limited in its conclusions.

In summary, this study contributes to filling the existing gap in the empirical literature on the specifics of corporate governance in state-owned enterprises. While most of the related research focuses on financial institutions, we examine the impact of board members' competencies and their divergent distribution between politically connected and non-political board members on corporate profitability. Thus, we extend the current understanding of competence and skills-based corporate governance research. Practitioners learn that the appointment of people with management experience from other sectors to the supervisory boards of SOEs should be viewed critically.

Apart from these initial statistical findings, no studies explicitly deal with the impact of board members who hold management experience from different than the analyzed industries. Consequently, our results provide a starting point for further research. For example, the question arises whether comparable results can also be found in state-owned enterprises in other sectors or even in the private sector. In other words, are our results a specific finding or do they represent a general pattern that is also present in different settings? Regarding the possible negative influence of overconfidence among managers without industry experience, future research could clarify whether such problems also exist in other industries or in the private sector, or whether overconfidence bias differs when analyzing politically and non-politically connected board members. In connection with this, it should also be investigated in the future whether other theory-based explanations can be used in addition to the explanatory approach of overconfidence bias applied here.

Also, the integration of the public service character of SOEs both in the concept of board competence and in corresponding performance indicators appears to be a promising future approach. Thus, further approaches for future research activities arise not least from the limitations discussed above with regard to specifics of SOEs. For example, it could be investigated whether there are other types of competencies of supervisory board members beyond the business competences examined here that have an influence on the performance of SOEs. It could also be investigated whether there are other measures of performance than those analyzed here, which take into account the public mandate of SOEs in particular. This could include, for example, the degree of fulfilment of non-financial objectives (such as security of supply) or the adherence to objectives from the area of corporate social responsibility.