Director networks, turnover, and appointments

DOIhttp://doi.org/10.1111/eufm.12213
Published date01 January 2020
Date01 January 2020
DOI: 10.1111/eufm.12213
ORIGINAL ARTICLE
Director networks, turnover, and appointments
Luc Renneboog
1,2
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Yang Zhao
3
1
Department of Finance, Tilburg
University, PO Box 90153, 5000 LE
Tilburg, the Netherlands
2
European Corporate Governance
Institute (ECGI), Brussels
Email: Luc.Renneboog@uvt.nl
3
Newcastle University Business School,
Newcastle upon Tyne NE1 4SE, UK
Email: yang.zhao@ncl.ac.uk
Abstract
This paper analyzes the labor market (turnover and
appointments) of executive and non-executive directors
by means of social network methodology. We find that
directors with strong networks are able to obtain labor
market information that enables them to leave their firm
more easily for better opportunities. Networks also mitigate
information asymmetry problems of external director
appointments. Furthermore, the strong impact of indirect
connections is in line with the strength of the weak ties
theory. The fact that direct connections are less important
signifies that the connections to people that are close and
local are likely to convey redundant information, whereas
connections to distant individuals are more efficient
in terms of information acquisition and labor market
performance improvement.
KEYWORDS
corporate governance, director appointments, director networks,
director turnover
JEL CLASSIFICATION
G34, J4, L14
1
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INTRODUCTION
A company's shareholders are to elect or approve the appointment of the non-executive (or
supervisory) directors whose fiduciary duties include monitoring the CEO and the other executive
directors (the management). In case of continued poor corporate performance, one of the key
responsibilities of the board is to contemplate the dismissal of the underperforming executives and to
The authors are grateful to an anonymous referee and associate editor for their helpful comments and suggestions.
Eur Financ Manag. 2019;133. wileyonlinelibrary.com/journal/eufm © 2019 John Wiley & Sons, Ltd.
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appoint successors. In this context, both networks of the executive and non-executive directors are
likely to play an important role; the former network can facilitate the search for a new position in
another firm, while the latter connections yield information on the pool of successors. The role of social
networks in job searching has been well studied in sociology and labor economics for laborers and
employees belonging to minorities, but has not been examined intensively for corporate top
management. Given that close professional and social connections exist among the corporate elites, it
may well be that executive and non-executive director networks are even more important in a labor
market context than employeesconnections. Contrary to many existing studies that only focus on the
CEO turnover, we evaluate the turnover and succession of all board members, comprising the CEO,
executive directors, chairman, and non-executive directors.
1
We address the question: To what extent do director networks affect the top managerial labor
market? We embed social network methodology into our analysis of this labor market and focus more
specifically on two issues. First, we examine whether, through his corporate network, a director may be
able to obtain information about which firms are seeking managerial profiles fitting the top manager,
and this may improve the odds of finding a similar or better managerial position. Thus, a strong network
may affect an executive director's decision to leave when he feels threatened by an approaching
dismissal. His network may enable him to leave his company at an earlier opportunity and prior to
dismissal. An executive director's network could also be a reflection of his power or influence which
could affect the board's decision-making and stall or ward off dismissal. As corporate under-
performance may not only be the responsibility of executive directors but also of the non-executive
directors on the board, we also study the impact of networks on the replacement of non-executives.
Although turnover has been shown to strongly correlate with poor corporate performance, (executive)
directors may also decide to leave well-performing firms in order to use their networks to take
advantage of opportunities. They could then depart voluntarily in order to join a larger firm and/or to
obtain a better remuneration package, or to pursue a promotion (e.g., from CFO to CEO). Second, we
turn to the perspective of the firm and examine the board's decision about hiring an internal versus an
external candidate when a managerial or non-executive vacancy emerges. In general, an external
director appointment involves more uncertainty due to asymmetric information, but the incumbent
directorsnetworks mitigate the uncertainty. In the context of turnover and appointment, we focus on
network centrality measures capturing the information-gathering potential of directors and companies.
Different types of centrality measures capture directorsconnections to nearby and powerful other
directors as well as directorspositions within the whole network.
This study yields some interesting results: first, directors with better global information access
(through indirect networks) are more likely to leave their current position for another firm. In contrast,
executive and non-executive directorsaccess to local information (proxied by direct connections) is
not correlated with the probability of their departure. Nevertheless, a director with many direct
connections stands a better chance of promotion and retention within his firm as the direct connections
may be a proxy for his influence or power in his firm. Second, when we investigate the factors affecting
the probability of an external appointment, it turns out that outside candidates with strong indirect
networks (with higher global information collection ability) are more likely to be chosen as the new
chairman or as non-executive directors. Specifically for the position of chairman, an external director
1
In this paper, we use the UK definition of director, which refers to both executive and non-executive directors. Whereas in
the United States, directorsusually refer to the non-executive directors who do not hold an executive position in the firm,
we apply the UK terminology throughout the paper: the board comprises both executive and non-executive directors. The
former category consists of the top management and the latter of (mostly) independent supervisor directors. So, in this
paper, directorsstand for both executive and non-executive directors.
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with a strong direct connectedness has a higher probability of being invited to chair the board. We do
not observe similar relations for executive directors. We conclude that director networks grant
information access and hence enhance the directorslabor market opportunities. The positive impact of
indirect connections reflects the network's information value and is in line with the strength of the
weak tiestheory (Granovetter, 1973). This signifies that the connections to people that are close and
local are likely to be stronger but then also convey redundant information. In contrast, connections to
individuals on brokeragepositions, for instance, bridging to groups that are otherwise separated, are
more efficient in terms of information acquisition and labor market performance improvement, even
though such connections may only be indirect and hence weaker.
When analyzing each company's position in networks at the company level, we reveal that the
information-gathering ability of a company, measured as the collective network of its individual
directors, is positively related to the probability of hiring external non-executive directors (including
chairmen). This implies that the network's information value affects labor market behavior at the
director as well as at the company level.
Our results reaffirm some findings in the recent literature, for instance, the information value of
CEOsnetworks increases t heir turnover probability (Liu, 2014), which w e extend by examining the
networks of the whole corporate board. We also discover that directorsdirect and indirect
connections affect turnover in different ways. Furthermore, we study the director appointment
decision from both the hiree's and company's perspective. External and internal appointments have
received less attention in the literature, but have strong implications for board diversity and
non-executive director independence. We find that the candidate's and the incumbent directors
networks increase the probability of external appointments and hence enable the firm to cast
their net wider, beyond the poo l of internal candidates. Lastly, our empirical analy sis is based on UK
data, which generates som e new insights into the director turnover literat ure currently dominated by
US evidence.
The paper proceeds as follows. In the next section, we review the CEO labor market studies. In
section 2, we introduce social network methodology and develop the hypotheses for our empirical
analysis in section 3. In section 4, we describe the sample statistics, followed in section 5 by our
multivariate analysis. In section 6, we formulate our conclusions.
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THE LITERATURE
2.1
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Director turnover
The pioneering empirical studies include those by Coughlan and Schmidt (1985), Weisbach
(1988), and Warner, Watts, and Wruck (1988), who reveal that CEO turnover is associated with
poor performance, especially when an effective corporate governance system is installed. Since the
early 1990s, studies on CEO turnover probability and corporate underperformance have been
conducted: for example, Kaplan and Minton (2012) and Bushman, Dai, and Wang (2010)
demonstrate that the turnover decision is closely related to the (relative) corporate performance,
and this relationship has become stronger after 2000. Although in principle, turnover decisions
ought to be made after filtering exogenous factors out of the corporate performance, Jenter and
Kanaan (2015) demonstrate that CEOs are fired following industry and market shocks that are
beyond their control.
CEO turnover is not only driven by poor performance but also affected by many other factors, the
remaining contract time of the incumbent director (Cziraki & Groen-Xu, 2017), board size (Renneboog
& Trojanowski, 2003; Yermack, 1996), large outside ownership (Denis, Denis, & Sarin, 1997), overall
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