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E-MailAlexander Ljungqvist is Ira Rennert Professor of Finance and Entrepreneurship at New York University Stern School of Business; Konrad Raff is Associate Professor of Finance at the Norwegian School of Economics. This post is based on their recent paper.
In our paper Busy Directors: Strategic Interaction and Monitoring Synergies, we examine when having a busy director on the board is harmful to shareholders and when it is beneficial. “Busy” directors—individuals who serve on multiple boards—continue to be the subject of debate among academics, practitioners, and policymakers. We develop and test the hypothesis that two factors jointly determine whether a busy board is beneficial or harmful to shareholders: (a) the existence of monitoring synergies across firms when directors serve on multiple boards, and (b) strategic interaction among directors on a firm’s board.
The policy debate implicitly assumes that busy directors experience negative monitoring synergies because time constraints prevent them from effectively monitoring all the firms on whose boards they serve. Our analysis nests this received wisdom but also allows for the possibility that a director with multiple board seats may experience positive monitoring synergies across firms. Positive synergies arise when the information or expertise acquired in monitoring one firm is transferable across firms.
Surprisingly, positive monitoring synergies are neither necessary nor sufficient for shareholders to benefit from the presence of busy directors, and similarly, negative synergies are neither necessary nor sufficient for shareholders to be harmed by busy directors. What is also important is the way directors interact with each other. We borrow the notion of strategic interaction among a group of agents carrying out a set of tasks from the literatures on personnel economics and organization economics and allow directors to condition their monitoring choices on their co-directors’ choices. Adapted to the board setting, strategic interaction implies that each director’s incentive to monitor the firm depends on her expectation of the other directors’ monitoring efforts. Monitoring efforts can be strategic complements or strategic substitutes. With strategic substitutability, increased monitoring by one director reduces the other directors’ incentives to monitor. With strategic complementarity, directors benefit from each others’ efforts, so that more monitoring by one director increases the other directors’ incentives to monitor.
According to the personnel- and organization-economics literatures, strategic interaction among members of a team can arise for a variety of reasons. For example, social pressure or image concerns can lead to strategic complementarity. Applied to our setting, a director may step up her monitoring effort if she expects her co-directors to devote more effort to monitoring, in order to avoid the stigma of shirking or the resentment of her peers. Alternatively, social pressure or image concerns can give rise to strategic substitutability instead: if individuals seek distinction, more effort by other team members may weaken incentives because it limits the opportunity to stand out from the crowd. Applied to our setting, better attendance by other directors may reduce a director’s incentive to attend board meetings because the reputational value of a good attendance record may be low if co-directors also have good attendance records. Finally, strategic interaction can arise for technological reasons, reflecting the nature of the team’s tasks. Investigating managerial misconduct or accounting fraud can, for example, lead to strategic complementarities because an individual director’s effort to curb such behavior may be more effective if other directors devote effort to this task as well.
The interplay between synergies across firms and strategic interaction among directors on a firm’s board can give rise to seemingly counterintuitive results that challenge the received wisdom that busy directors are harmful. Shareholders may benefit if an attention shock forces a busy director to monitor another firm more closely, for two reasons: either there are positive cross-firm monitoring synergies and the shocked director becomes more effective at monitoring non-shocked firms as well; or, in the case of negative synergies, less attention by the busy director may trigger overcompensating reactions by the other directors as a result of strategic substitutability.
Our empirical analysis is designed to shed light on when having a busy director on the board is harmful or beneficial to the shareholders of U.S. companies. To do so, we combine an empirical measure of the likely sign of monitoring synergies with a series of exogenous shocks to how busy a director with multiple board appointments is on one board and examine how this distraction spills over to the director’s other boards. The shocks occur as result of a natural experiment first proposed by Kelly and Ljungqvist (2012). Between 2000 and 2008, 43 brokers closed their research operations as a result of adverse changes in the economics of sell-side research. The closures led to over 4,000 analyst coverage terminations among stock market listed U.S. firms.
We conjecture that the directors of the affected firms, when faced with a reduction in external monitoring by analysts and by other parties that rely on analyst research, step up their own internal monitoring. The data strongly support the conjecture that directors become busier after coverage terminations. We then test how directors who also serve on other boards besides the shocked firm adjust their monitoring efforts on their other boards. For the average firm, we find a reduction in their monitoring at spillover firms, consistent with negative monitoring synergies being predominant in the data. This reduction masks interesting heterogeneity: among pairs of shocked and spillover firms that plausibly enjoy positive monitoring synergies (such as firms operating in related industries or those whose fundamentals help predict each other’s financial performance), we find that busy directors increase their monitoring efforts at both firms, consistent with the model’s predictions.
Next, we examine the response of the spillover firm’s other directors to the adjustment the common director makes to her monitoring effort. Focusing on economically meaningful shocks, we find that monitoring adjusts at spillover firms. On average, the mode of interaction is best described by strategic complementarity, both when monitoring synergies are positive and when they are negative. The exception, in our data, occurs when a firm is in a crisis situation, in which case the efforts of the non-shocked directors and the shocked director move in opposite directions, consistent with strategic substitutability. In crisis situations, the utility cost to directors of a monitoring shortfall is likely particularly large, such that a reduction in one director’s monitoring effort raises the need for the other directors to optimally exert more effort to compensate
Our empirical findings are consistent with directors’ monitoring efforts typically being characterized by strategic complementarity, regardless of the sign of the cross-firm monitoring synergies, but switching to being strategic substitutes in times of crisis. In light of these empirical findings, our model suggests that having a busy director on the board is typically only going to be harmful when the firms on whose boards she serves have so little in common informationally that tight time constraints result in negative monitoring synergies. Firms linked by positive monitoring synergies, on the other hand, are going to benefit from sharing directors, especially when their common directors become busier on another of their boards. We confirm these predictions using an event study of spillover firms’ abnormal returns to the announcement of a (meaningfully large) exogenous reduction in research coverage at another firm to which they are linked through a board interlock.
The complete paper is available for download here.
