Olubunmi Faleye

Does one hat fit all? The case of corporate leadership structure

Recent corporate scandals have led to renewed campaigns for governance reforms, including calls for the separation of CEO and chairman positions. This paper argues that this trend ignores the possibility that differences in firm characteristics determine the appropriateness of separating or combining the two positions. I propose and test hypotheses on the determinants of leadership structure using a sample of 1,883 firms. I find that organizational complexity, CEO reputation, and managerial ownership increase the probability of CEO duality. I also find that whether CEO duality benefits or hurts the firm is contingent on firm and CEO characteristics. These results suggest that firms do consider the costs and benefits of alternative leadership structures, and that requiring all firms to separate CEO and chairman duties may be counterproductive.

Do Better-Connected CEOs Innovate More?

We present evidence suggesting that chief executive officer (CEO) connections facilitate investments in corporate innovation. We find that firms with better-connected CEOs invest more in research and development and receive more and higher quality patents. Further tests suggest that this effect stems from two characteristics of personal networks that alleviate CEO risk aversion in investment decisions. First, personal connections increase the CEO’s access to relevant network information, which encourages innovation by helping to identify, evaluate, and exploit innovative ideas. Second, personal connections provide the CEO with labor market insurance that facilitates investments in risky innovation by mitigating the career concerns inherent in such investments.

Classified Boards, Stability, and Strategic Risk Taking

Classified boards are the focus of recent shareholder activism aimed at improving U.S. corporate governance. Although critics argue that classified boards reduce directors’ effectiveness, proponents counter that they enhance corporate stability, board independence, and long-term strategic risk taking. Based on hand-collected data, this study found that stability was similar for both classified and nonclassified boards and that continuity rates for independent directors were comparable for both categories. The study found as well that companies with classified boards invested less in R&D and other company-specific capital assets. These findings were also true for companies with relatively complex operations that are often considered most likely to benefit from classified boards. Classified boards are the focus of recent shareholder activism aimed at improving U.S. corporate governance. According to Institutional Shareholder Services, 46 shareholder proposals to declassify boards received an average of 60.5 percent favorable votes in 2005; that number increased to 66.8 percent for 42 such proposals voted on by 30 June 2006. On the basis of studies that examined the stock price reaction to adoptions of classified boards and studies that analyzed the impact of classified boards on hostile-takeover activities, critics argue that classified boards harm shareholders by facilitating managerial entrenchment and reducing directors’ effectiveness. Proponents counter that classified boards enhance corporate stability, board independence, and long-term strategic risk taking. To examine these claims empirically, I used hand-collected data for a sample of 2,072 companies in the 1995–2002 period. First, I analyzed the effect of classified boards on long-term board stability, which I defined as the proportion of 1995 directors remaining on the board as of the end of 2002. For companies with classified boards, 58.9 percent of 1995 directors remained on the board as of the end of 2002, compared with 60.5 percent for companies that elected all directors annually. I obtained similar results for two categories of directors: 59.0 percent of affiliated directors and 59.5 percent of independent directors remained on classified boards, compared with 61.1 percent and 59.5 percent for nonclassified boards. None of these differences is statistically significant, which indicates that electing directors to staggered terms does not enhance board stability any more than electing all directors annually and that independent directors do not last any longer than affiliated directors on classified boards. These conclusions remained unchanged when I controlled for other factors that can affect board stability by using a multiple regression framework. Next, I examined the effect of classified boards on corporate investment in long-term, company-specific capital assets by focusing on expenditures for research and development and net investments in property, plant, and equipment (PP&E). On average, companies with classified boards invested 2.1 percent of their assets in R&D, compared with 4.3 percent for companies with nonclassified boards. Similarly, classified boards increased their net PP&E by 19.8 percent, compared with 20.6 percent for nonclassified boards. Even among companies in complex industries (e.g., pharmaceuticals, electronics, and software development) in which investment in R&D and other company-specific assets is critical for success, those with classified boards spent less on R&D and net PP&E—5.0 percent and 11.5 percent, respectively, compared with 9.3 percent and 15.5 percent for companies with nonclassified boards. Overall, these results are difficult to reconcile with the notion that classified boards enhance directors’ ability to focus on long-term strategy. Finally, I analyzed the effect of classified boards on wealth creation among companies subject to a high degree of operating uncertainty because of the complexity of their business. This group is commonly considered most likely to benefit from having classified boards; nevertheless, I found evidence contradictory to such beliefs. Regardless of how I defined operating complexity, I found that classified boards always had a negative impact on the creation of shareholder value. These results weaken some of the strongest arguments in support of classified boards. That classified boards have powerful antitakeover effects is generally accepted and has been empirically shown. Nevertheless, many proponents support classified boards because they are thought to promote corporate stability. The findings indicate that this claim is without merit and suggest that justifying classified boards on the basis of furthering stability is problematic. Rather, the current wave of shareholder activism aimed at declassifying corporate boards appears to be well justified.

Are Large Boards Poor Monitors? Evidence from CEO Turnover

This paper examines the relation between a boards size and its monitoring effectiveness by exploring how board size affects different aspects of the CEO replacement process. I find that the probability of CEO turnover is significantly negatively related to board size, and that the abnormal return accompanying turnover announcements decreases with board size. I also find that larger boards are less likely to appoint an outsider to succeed the terminated CEO. These results suggest that a large size hinders the boards ability to perform its monitoring functions, and lends additional support to the current drive toward smaller boards.

Risky Lending: Does Bank Corporate Governance Matter?

We study the effect of bank governance on risk-taking in commercial lending. Banks with more effective boards are less likely to lend to riskier borrowers. This effect is restricted to periods of distress in the banking industry and is stronger at banks with board-level credit committees. Banks with more effective boards are less likely to lend to riskier borrowers right after the Russian default, which exogenously imposed distress conditions on U.S. banks. Thus, value-maximizing banks appear to ration credit to riskier borrowers precisely when such firms might be credit-constrained, suggesting that bank governance regulations may have potential unintended consequences.

Are Entrepreneurs Special? Evidence from Board Appointments

We study the appointment of entrepreneurs as outside directors to examine their effect on corporate outcomes in firms not created by them. Entrepreneur directors are more likely to join smaller firms and firms whose founders currently serve as directors. Appointments of entrepreneur directors attract higher stock price reactions than appointments of other outside directors and firm value increases with the number of entrepreneur directors. The value effect is greater when the firm is smaller or operates in more competitive industries. Entrepreneur directors are also associated with higher corporate risk-taking, increased R&D investments, and improved revenue growth.

The Determinants and Effects of CEO–Employee Relative Pay

We study the determinants and effects of the relative compensation of top executives and lower-level employees. First, we show that CEO–employee pay ratio depends on the balance of power between the CEO (relative to the board) and ordinary employees (relative to management). Second, our results suggest that employees do not perceive higher pay ratios as an inequitable outcome to be redressed via costly behaviors that lower productivity. We do not find a negative relation between relative pay and employee productivity, either in the full sample or in subsamples where employees are well-informed about executive pay and are protected against retaliatory managerial actions. Rather, we find that productivity increases with relative pay when the firm has fewer employees who are well-informed, and when promotion decisions are predominantly merit-based. We also find that firm value and operating performance both increase with relative pay. We conclude that ordinary employees appear to perceive an opportunity in higher pay ratios but the extent to which such perception incentivizes them depends on the likelihood of success in a promotion tournament.

Merger Spillovers in Collaborative Partnerships

We examine whether a firm in a collaborative partnership experiences spillover effects from the merger of its partner with a third firm. We find that merger announcement return to the non-merging partner is positive. Its match-adjusted sales growth and operating income in the year following the merger are also positive. Further tests suggest that the spillover effects arise from increased synergies created by the merger for the non-merging partner. Other potential sources of merger spillover effects including the relaxation of financial constraints and an increased likelihood that the non-merging partner will subsequently become a takeover target appear to be less important.