Lessons Learned From Studying Corporate Governance

Tuesday, December 28, 2004

Prof. Anil Shivdasani & Marc Zenner, University of North Carolina, http://

Abstracted from: Best Practices In Corporate Governance: What Two Decades Of Research Reveals
By: University of North Carolina (AS); Citigroup, New York, NY (MZ)
Journal of Applied Corporate Finance - Vol. 16, Nos. 2-3, Pgs. 29-36

Independent boards bargain better, internally and externally.
Twenty years of research can reveal important understandings about corporate governance. Finance professor Anil Shivdasani and investment banker Marc Zenner reviewed their own and other researchers' studies to discern strategies for enhancing shareholders' value. Independent boards, they report, represent shareholder interests better, both within the company, when dealing with management, and outside the company, when negotiating mergers and acquisitions. Largely independent boards monitor CEO performance more closely and are more likely to replace an underperforming CEO. When the board announces an acquisition, the markets respond more favorably to the announcement. If the company is the target, the independent board drives a harder bargain with the acquiror. Independent boards facilitate good decisions in specific areas, but overall financial performance does not appear to be directly linked to the percentage of outside directors. When companies perform badly, however, they are likely to add independent directors, an event greeted positively by investors.

Stock options improve performance up to a point.
Ownership of stock by the CEO and managers tends to improve valuation multiples. When managers have a personal vested interest in the company's stock performance, their decisions focus on augmenting stock value. Granting options is thus a good incentive to maximize shareholder value. If the CEO owns too much stock, however, the advantages decrease. Once the CEO dominates the company, the authors report, the results may slip into reverse. If the CEO becomes the controlling shareholder, the board's control of the chief executive's behavior vanishes and other stockholders may suffer. Compensation packages thus need to include enough stock options to motivate management to increase stock value, but not so much that other shareholders find themselves dominated by inside owners.

Board structure influences decisions.
Since boards typically rule by a simple majority, little is accomplished by adding independent directors once the independents have attained a majority, the authors also learned. Companies benefit by having some insider directors, who can provide a perspective that independent directors lack. Independent nominating committees facilitate the nomination of independent directors rather than affiliated outside directors or insiders. Independent auditing committees produce more informative earnings and financial reports, but if the CEO sits on either of these committees, the reverse is true. When the CEO sits on the compensation committee, cash compensation is likely to be considered excessive by outsiders.

Watch the board's size.
The best performing boards among the 500 ranked by Forbes had eight or fewer board members, while boards with more than 14 members displayed the worst performances. The authors advise that large boards should not immediately cut directors, because investors could interpret the loss of a respected director as a negative indicator. Nonetheless, boards seem to function more efficiently when not overly large. How many directorships one person holds yields mixed results in terms of the board's quality; as a general rule, stockholders benefit from having boards that are not cluttered with excessively busy directors. Board members who are too busy with other boards and commitments detract from the overall performance and weaken the board's control.

Abstracted from Journal of Applied Corporate Finance, co-published by Stern Stewart & Company, 135 East 57th Street, New York, NY 10022,

Return to Library of Business Information