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Contrary to prevailing view, serving on other firms' boards not only does no harm to CEOs' home companies but often boosts their performance

May 1, 2011

For more information, contact: Benjamin Haimowitz,

According to a leading executive-search firm, CEOs and other top executives are the most ardently sought individuals for directorships of other companies. Yet, nowadays they make up only about one fourth of newly appointed independent corporate directors, where a decade ago they constituted about half.

The drop reflects a view that began to gather force in the early 1990s -- namely, that executives' service on corporate boards may be all well and good for the firms in which they serve as directors but is detrimental to their home companies. Outside service, it is widely believed, distracts top executives from their primary home-company responsibilities, gives a superfluous boost to already ample egos, and, in sum, constitutes little more than a form of managerial opportunism.
So prevalent have these notions become that announcements of CEO appointments to outside boards commonly occasion declines in their home-companies' stocks.
Now a study in the current issue of The Academy of Management Journal calls these prevailing beliefs and prejudices into question. The new research not only "fail[s] to uncover evidence that CEO service on outside boards poses a significant detriment to firm performance" but finds that "in many contexts, long-term profitability [of the home company] is enhanced."
Three circumstances in particular, the study finds, lend themselves profitably to outside CEO board directorships -- low growth, high market fragmentation, and lesser company diversification.
"It seems ironic that in the present period of low growth, many firms are under the impression that having their top executives serve on outside corporate boards is a luxury they can't afford," comments Marta A. Geletkanycz of Boston College, a co-author of the study with Brian K. Boyd of Arizona State University. "Our findings suggest that it is especially in the context of low growth that CEO service on an outside board is most advantageous to the chief's own firm."
"After all," Boyd explains, "low growth means heightened competition, as companies are forced to pursue each other's customers. Serving on outside boards affords executives extra exposure to competitive strategies in circumstances where they are most needed."
He adds: "The notion that outside directorships are bad for executives' home companies is the modern corporate equivalent of bloodletting -- something widely believed in even though its principal effect is merely to weaken the host."
The authors' convictions on this point emerge from an investigation of the financial performance of 460 randomly chosen manufacturing and service firms from among the 1000 largest US corporations in 1987, that year being chosen because it "preceded the widespread curbing of executive outside directorship activity." A count of outside directorships of the firms' CEOs during that year was analyzed with respect to the firms' financial performance (return on assets and return on sales) over the subsequent five years. In addition, the professors analyzed the effect of three factors that, they hypothesized, would influence the relationship between outside directorships and firm performance -- 1) the growth rate of each home-company's industry; 2)  the amount of concentration in the firm's industry (ranging from 0 for perfect competition to 1 for monopoly); and 3) each company's degree of diversification.
For the sample as a whole, no significant relationship was found -- neither positive nor negative -- between outside directorships of CEOs and their companies' financial performance over the subsequent five years. But when the sample was broken into sub-groups on the basis of the hypothesized factors, all three proved to have a considerable effect. Thus, in low-growth industries, low-concentration industries, and relatively undiversified firms -- in all three groups -- CEOs' outside directorships translated into markedly superior financial performance.
In the words of the study, "CEO outside directorships are neither uniformly beneficial nor detrimental to the firm success...Outside directorship ties are beneficial in contexts where firms face competitive constraints owing to low demand growth and market fragmentation (low concentration)...By broadening the CEO's environmental scan and providing exposure to a diverse array of strategic alternatives, the firm enjoys richer executive-level insight into the environment, as well as varied methods of competition."
As for diversification, the benefit of outside directorships is generally limited to less diversified firms in which "business strategy serves as a focal responsibility of the chief executive." In more diversified firms, in contrast, "the CEO's responsibility shifts toward more of a financial, coordination role."
Despite the evidence that the benefits of outside directorships largely depend on particular circumstances, no evidence of ill effects emerged for firms in opposite circumstances -- in other words, highly diversified companies and firms in high-growth, high-concentration industries.  In short, where CEO outside directorships are concerned, the fact that the right firms gain does not mean that the wrong firms lose.
In conclusion, the professors note that "recent surveys report that two thirds of major (S&P) firms now impose a limit on CEO service on outside boards, with many adopting outright proscriptions. Our findings indicate that firm owners are likely better served not by blanket prohibition of outside board service but instead a more customized approach."
The new study, entitled "CEO Outside Directorships and Firm Performance: A Reconciliation of Agency and Embeddedness Views," is in the April/May issue of the The Academy of Management Journal.  This peer-reviewed publication is published every other month by the Academy, which, with about 19,000 members in 103 countries, is the largest organization in the world devoted to management research and teaching. The Academy's other publications are the The Academy of Management Review, The Academy of Management Perspectives and Academy of Management Learning and Education.
Media Coverage:
The Globe & Mail. Bottom line gets a boost when leader joins other boards. (Monday, May 16, 2011).
The Wall Street Journal. Study points to benefits of outside board seats. (Monday, May 23, 2011).

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