Ineffective corporate governance: Director busyness and board committee memberships

Journal of Banking & Finance 33 (2009) 819–828

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Ineffective corporate governance: Director busyness and board committee memberships Pornsit Jiraporn a, Manohar Singh b,*, Chun I. Lee c a

Pennsylvania State University, United States Willamette University, Atkinson Graduate School of Management, 900 State Street, Salem, OR 97301, United States c Loyola Marymount University, United States b

a r t i c l e

i n f o

Article history: Received 28 February 2008 Accepted 10 September 2008 Available online 1 October 2008 JEL classification: G32 G34 G38 Keywords: Multiple directorships Board committees Corporate governance Sarbanes–Oxley act

a b s t r a c t Our paper examines whether holding multiple outside board seats compromises a director’s ability to effectively perform monitoring duties. Analyzing over 1400 firms, we report that individuals who hold more outside directorships serve on fewer board committees. The relation, however, appears non-linear, U-shaped, and in support for both the busyness and the reputation hypotheses. In addition, we find that holding more outside board seats decreases the likelihood of membership on compensation and audit committees. The findings substantiate evidence [Akhigbe, A., Martin, A.D., 2006. Valuation impact of Sarbanes–Oxley: Evidence from disclosure and governance within the financial services industry. Journal of Banking and Finance 30 (3), 989–1006] of value relevance of board committee structures. Additional analysis of committee memberships suggests that women and ethnic minorities are placed on more board committees. Also, directors on smaller and independent boards serve on more committees. Finally, it appears that the Sarbanes–Oxley act had a material impact on the association between the number of multiple board seats and committee memberships. Ó 2008 Elsevier B.V. All rights reserved.

1. Introduction The National Association of Corporate Directors (NACD) guidelines recommend that senior corporate executives and CEOs should hold no more than three outside directorships. Likewise, the corporate governance policies of the Council for Institutional Investors (CII) suggest that individuals with full-time jobs should not serve on more than two other boards. In academia, the debate on the costs and benefits of multiple directorships continues. The early literature argues for the benefits of individuals holding multiple board seats. Multiple directorships can add value by enhancing executive experience (Carpenter and Westphal, 2001) and by permitting the executive to establish a network or to monitor business relations (Mace, 1986; Loderer and Peyer, 2002). On the contrary, Ferris et al. (2003) and Fich and Shivdasani (2006) contend that directors holding a larger number of outside board seats may be overcommitted, thereby causing poor corporate performance. Several studies examining the link between broad firm performance and multiple board seats have produced ambiguous results (Ferris et al., 2003; Fich and Shivdasani, 2006; Perry and Peyer, 2005; Jiraporn et al., 2008). * Corresponding author. Tel.: +1 610 725 5342; fax: +1 610 725 5224. E-mail addresses: [email protected] (P. Jiraporn), [email protected] (M. Singh), [email protected] (C.I. Lee). 0378-4266/$ - see front matter Ó 2008 Elsevier B.V. All rights reserved. doi:10.1016/j.jbankfin.2008.09.020

While the existing literature suggests that there is a link between directors’ busyness and corporate performance (although without conclusive evidence), we still do not understand in what way directors’ busyness affects firm value. By examining the relation between board members’ busyness and their ability to serve on committees, we make a modest contribution to the debate on the association between directors’ busyness and firm performance. We provide evidence that one possible channel of influence of director busyness on corporate value may be through their inability to serve on board committees. The empirical evidence suggests that the number of outside directorships is related to the number of internal board committees on which the director serves. The relation, however, is more complex than might have been expected. Specifically, it is non-linear and negative up to a certain point, and then it turns positive. In other words, individuals holding multiple board seats are likely to serve on fewer internal board committees as long as the number of outside directorships does not exceed a certain value. Beyond that value, serving on board committees increases in number of directorships. The results of this study enrich the literature in several ways. First, this study contributes to the limited, albeit rapidly growing, literature on directors’ busyness. Second, the results of this study augment the literature on board diversity. We show that female and minority directors, in general, are likely to be placed on more

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internal board committees. Third, the literature on board structure also benefits from this study as we demonstrate that board size and board composition materially impact board committee assignments. Finally, we contribute to the literature on audit committees by demonstrating that directors’ busyness is a significant factor in determining audit committee membership. In conclusion, we provide evidence that board committee assignments are not random and can be empirically explained. The remainder of this study is structured as follows: Section 2 presents a literature review. Section 3 discusses the hypothesis development. Section 4 explains the sample selection procedure and describes the data. The empirical results are presented and discussed in Section 5. Finally, Section 6 offers the concluding remarks. 2. Literature review 2.1. Multiple directorships Fama (1980) and Fama and Jensen (1983) contend that the market for directorships functions as an important source of incentives for outside directors to develop reputations as monitoring specialists. Mace (1986) argues that outside directorships are regarded as valuable because they provide executives with prestige, visibility, and commercial contacts. Empirical support for the reputation argument can be found in a number of studies. The number of outside directorships is shown to be related to firm performance for financially distressed firms (Gilson, 1990), for firms that cut dividends (Kaplan and Reishus, 1990), for firms that opt out of stringent anti-takeover provisions (Coles and Hoi, 2003), and for companies that hire their CEOs following retirement (Brickley et al., 1999). As a result, the number of board seats held by an outside director has been used to represent the director’s reputation in the external labor market (Brown and Maloney, 1999). This line of argument suggests that firms, with an aim to increase their value, will have a demand for reputed directors (proxied by multiple board memberships) to serve on their boards. This positive value effect may be attributed to actual monitoring by reputed directors, to their expert advisory and boundary-expanding role, as well as to a positive signaling effect. More recent literature questions the wisdom of holding too many board seats. Multiple directorships may lower the effectiveness of outside directors as corporate monitors (Core et al., 1999; Shivdasani and Yermack, 1999). While Ferris et al. (2003) do not find a significant relation between the market-to-book ratio and the average number of board seats held by directors, Fich and Shivdasani (2006) report that busy directors can hurt firm performance. Specifically, they find that firms with boards where the majority of outside directors are busy (i.e., holding three or more directorships) have weaker corporate governance, lower marketto-book ratios, weaker profitability, and lower sensitivity of CEO turnover to firm performance. Perry and Peyer (2005) conclude that when executives have strong incentives to enhance shareholder value, the accumulation of board seats has a positive impact on firm value. Jiraporn et al. (2008) report that firms with busy boards are more likely to be diversified and suffer a deeper diversification discount. Finally, Conyon and Read (2005) show that executives choose to spend more time on external directorships than is optimal for the employing firm hurting firm performance. 2.2. Board committee memberships The extant literature suggests that board effectiveness is actuated through board committees. Not only are some of the most sig-

nificant decisions initiated at the committee levels (Kesner, 1988), functioning and structure of important committees like finance and accounting committees may influence corporate performance more than the overall board composition (Klein, 1998). Committees not only impact corporate performance by influencing corporate strategies (Vance, 1983), but also by reducing agency problems (Davidson et al., 1998). Laux and Laux (2008) suggest that pay-performance sensitivity is higher when the compensation committee sets the CEO pay and the audit committee monitors the financial reporting, rather than when the board as a whole handles both. There exits some empirical evidence on the conflict between serving on multiple boards and serving on committees. Ferris et al. (2003) provide preliminary evidence that busy directorships are not correlated with committee memberships. We extend Ferris et al.’s (2003) results in several ways. First, Ferris et al. (2003) make univariate comparisons between busy directors and their committee assignments. In this study, we control for a large number of relevant factors in a multivariate regression framework to clearly delineate the role of busyness in determining committee memberships. Second, Ferris et al. (2003) do not consider a non-linear relation between directors’ busyness and committee assignments. This study explicitly examines and finds a non-linear relation. Finally, Ferris et al. (2003) draw their conclusions based on a sample of 300 firms over two years. This study, on the other hand, examines more than 40,000 observations of director data over five years. With respect to value relevance of board committee characteristics, Akhigbe and Martin (2006) suggest that expertise and independence of committee members influence the impact of adoption of Sarbanes–Oxley act by financial services firms. Our paper adds to the literature on board committees’ value relevance by linking director busyness with director reputation and expertise as committee members. 3. Hypothesis development 3.1. The reputation hypothesis This hypothesis is based on the argument that multiple directorships are advantageous because they help executives develop managerial expertise. By sitting on many boards, an executive learns about different management styles or strategies used in other firms (Carpenter and Westphal, 2001; Perry and Peyer, 2005). Fama and Jensen (1983) suggest that the demand for the executive to serve as an outside director can be an independent certification or signal of the executive’s ability. Hence, competent executives with outstanding expertise are highly sought-after and are expected to hold many outside board seats. Due to their competence and extensive experience they are more likely to serve on a larger number of board committees than those not holding multiple directorships. This hypothesis, thus, predicts a positive relation between the number of board seats and the number of board committees. 3.2. The busyness hypothesis This argument, based on the busyness hypothesis advanced by Ferris et al. (2003), posits that individuals holding more outside board seats have less time to spend serving on board committees. At the cost of shareholders, executives may seek outside directorships because it improves their visibility and enhances their status. These private benefits may outweigh the benefits of serving on internal board committees. Thus, directors have much less to gain by serving on committees than by serving on more boards. On the other hand, firms may also be discouraged to put busy directors on

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committees as they are not expected to be able to do justice to their committee duties. As a result, this hypothesis predicts that an individual holding more outside board seats will serve on fewer internal board committees.

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work harder and offer their service by being on board committees. Hence, directors with higher ownership stakes are likely to serve on more board committees. 3.6. Structure of the full board

3.3. Possible non-linearity Multiple board seats determine both directors’ busyness and reputation. We argue that the link between board seats and committee memberships may not be fully captured in a simple linear relation. At lower levels of board memberships, busyness is expected to increase more than proportionally with increasing board seats. This may be, among other factors, due to learning curve effects. Once the learning curve phase is mature, directors’ busyness may increase only proportionally or even less with board seats. At lower levels of board memberships, directors’ reputation/expertise is not yet established, and firms do not put busy directors on committees as they have higher risk of being ‘‘too busy to mind the business”. At lower levels of board memberships, even directors may be unwilling to serve on several committees, as they are busy establishing a reputation and creating networks by joining multiple boards. Thus, we may find that at lower levels of multiple board seats there is a negative relation between board seats and committee memberships. Initially the reputation effect is expected to increase less than proportionally with increasing board seats. However, at higher levels of board seats, the reputation effect may grow more than proportionately with an increase in board seats. From a firm’s perspective, at higher levels of multiple board seats, for directors with a greater number of board seats, the reputation effect may outweigh the cost of the busyness effect. Thus, at higher levels of multiple board seats, firms may be inclined to put busier directors on several committees to tap their expertise or reputation benefits. Here, we would expect to a see a positive relation between board seats and committee memberships. In sum, we argue that the busyness and the reputation effects come into play at different levels of multiple board seats. Initially, at lower levels of board seats, the cost of busyness outweighs the benefits of expertise/reputation and hence greater busyness is associated with fewer committee memberships. The result is a negative relation between board seats and committee memberships. At higher levels of board seats, the benefits of reputation/ expertise outweigh the cost of being busy, leading firms to increasingly put busy directors on committees. This results in a positive relation between board seats and committee memberships. Overall, the relation between board seats and committee memberships may thus be a non-linear U-shaped one.

The nature of board committee assignments may be influenced by the structure of the full board, specifically board size and board composition. Smaller boards have fewer members. Thus, it is natural to expect each board member on such a smaller board to do more work by carrying more committee memberships. We hypothesize that directors on smaller boards serve on more board committees. As far as board composition, managerial oversight should be strongest on boards with a large percentage of independent directors. Specifically, governance experts recommend that audit, compensation, and governance committees be comprised of a majority of independent members. In addition, if outside directors are recruited for their expertise, it is conceivable that more outsiders will populate these board committees. As a result, we hypothesize a positive association between the percentage of independent directors on the board and the number of board committee memberships per director. 3.7. Potential endogeneity In the context of this study, the presence of endogeneity may imply that the number of multiple board seats not only influence, but in turn get influenced by the number of committee memberships. In addition, it is possible that some other factors (for example director reputation and expertise) jointly determine the variability in these two variables. We use Hausman test to detect potential endogeneity and correct for potential problems by utilizing 2SLS estimation technique. 3.8. The role of regulation It may be argued that serving on multiple outside boards may be a manifestation of directorial agency conflict. Because regulators already provide a certain degree of monitoring, executives of regulated firms may be less able to reap private benefits at the expense of shareholders (Booth et al., 2002). Thus, in regulated industries we expect to see that directors do not shirk their responsibilities and on average serve on a larger number of committees. 3.9. The Sarbanes–Oxley act

3.5. Equity ownership

Several recent studies document the significant effects of Sarbanes–Oxley act of 2002. For instance, Linck et al., 2008 report that boards of directors are larger and more independent post-Sarbanes–Oxley. Director pay increases substantially post-Sarbanes– Oxley, suggesting that Sarbanes–Oxley increases director workload and risk. Moreover, firms are likely to establish a nominating or governance committee post-Sarbanes–Oxley. Since the purpose of this Act is to combat agency costs, and serving on too many outside boards can be construed as an agency cost, one may argue that the passage of the Act may influence the behavior of board members.1 As a result, we hypothesize that the Sarbanes–Oxley act (2002) moderated the relation between multiple directorships and internal board committees.

The origin of agency costs lies in the divergence of ownership and control. One way to force managers’ and shareholders’ interests into closer alignment is to make managers own a substantial portion of the firm’s equity (Jensen and Meckling, 1976). We hypothesize that more equity ownership motivates directors to

1 The authors thank the reviewer for highlighting the possible influence of Sarbanes Oxley Act (2002) on the relation between board seats and committee assignments.

3.4. Minority directors Several corporate reformers have recommended increasing the representation of minorities on the board of directors (TIAA-CREF, 1997; NACD, 1994). It is conceivable that corporations attempt to comply with the political pressure and place more minorities on board committees as well as on the full board. If this is the case, minority directors should hold a higher number of board committee memberships. We test this proposition for ethnic as well as gender minorities.

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number of board committees is displayed in Table 1 Panel B. It is common for directors to serve on at least one committee. Only 26.6% of the directors serve on none of the committees. Only 2.5%, of the directors serve on all four.

4. Sample selection and data description 4.1. Sample selection The initial sample is obtained from the Investor Responsibility Research Center (IRRC) available through the Wharton Research Data Service (WRDS). The IRRC collects data on corporate governance and directors for about 1,500 firms. The sample period spans five years from 1999 to 2003. We drop observations with insufficient firm data on COMPUSTAT. There are 41,475 observations from 1471 firms in the final sample. This sample is substantially larger than those of any previous studies, thereby increasing the statistical power of the results. 4.2. Multiple directorships Following Perry and Peyer (2005), we measure directors’ busyness by the number of outside directorships they hold. Table 1 Panel A shows the distribution of the number of outside board seats held. 52.2% of the directors in the sample hold no other directorships while 22.7% hold one outside board seat. The highest number of outside directorships in the sample is ten.

The IRRC reports several individual characteristics. Each director is shown to be either male or female. A binary variable is set to one for a female director and zero otherwise. Race is also identified. For the purpose of this study, we define an ethnic minority director as a person of African–American, Hispanic, or Asian origin. A dichotomous variable is created that is equal to one if the director is a member of the minority groups and zero otherwise. Directors are classified into insiders, affiliated, or independent as in Baysinger and Butler (1985). We create a variable that is set to one if the director is an independent outside director and zero otherwise. Equity ownership held by each director is reported as well. We define ownership as the percentage of total equity owned by each director. 4.5. Descriptive statistics and univariate comparisons Summary statistics are reported in Table 2. As in Ferris et al. (2003), we report descriptive statistics for two groups of directors.

4.3. Internal board committees The IRRC reports whether a given director is on the following board committees or not: (1) audit committee, (2) compensation committee, (3) nominating committee, and (4) corporate governance committee. Although, one would gain a better understanding of the relation between committee memberships and board seats by studying all board committees, the data availability constraints limit the study to only the four major committees. We construct a dichotomous variable indicating the presence of a given director on each committee. Thus, there are four dummy variables corresponding to the four internal board committees. For each director, we add these dummies together to obtain the number of board committees the director serves on. The number of committees ranges from zero (serving on none of the committees) to four (serving on all of the committees). The distribution of the

Table 1 Distribution of the number of board committees and the number of outside directorships Frequency

4.4. Directors’ characteristics

Percent (%)

Cumulative percent (%)

Panel A: Distribution of the number of outside board seats held by each director No. of outside directorships 0 21,665 52.2 52.2 1 9410 22.7 74.9 2 5498 13.3 88.2 3 2773 6.7 94.9 4 1237 3.0 97.8 5 502 1.2 99.1 6 210 0.5 99.6 7 104 0.3 99.8 8 52 0.1 99.9 9 18 0.0 100.0 10 6 0.0 100.0 Total 41,475 100.0 Panel B: Distribution of the number of board committees held by each director Four committees are included in the analysis; audit, compensation, nominating, and corporate governance No. of committees 0 11,045 26.6 26.6 1 13,500 32.5 59.2 2 9812 23.7 82.8 3 6083 14.7 97.5 4 1035 2.5 100.0 Total 41,475 100.0

Table 2 Summary statistics and univariate comparisons Non-busy (less than 2 outside directorships) Mean (Median)

Busy (2 or more outside directorships) Mean (Median)

Difference

Panel A: Director characteristics Age 59.12 (59.00) Minority 0.04 (1 if minority) (–) Gender 0.09 (1 if female) (–) Independent director 0.61 (1 if independent) (–) Equity ownership (%) 1.53% (0.00%)

60.93 (61.00) 0.09 (–) 0.12 (–) 0.78 (–) 0.54% (0.00%)

21.14***

Panel B: Firm characteristics Sales 4536 (1386) Total assets 5316 (1512) Debt ratio 45.47% (45.93%) EBIT ratio 7.67% (8.57%)

9081 (3421) 11,024 (3647) 48.33% (47.70%) 7.41% (8.63%)

–25.54***

Panel C: Board characteristics Board size 9.57 (9.00) % Independent directors 63.75% (66.67%) No. of board committees 1.25 (1.00) N 31,074

10.47 (10.00) 70.24% (72.73%) 1.61 (1.00) 10,401

29.73***

(t-statistics)

– – – 18.08***

25.16*** 14.15*** 1.40

34.33*** 28.98***

Directors holding at least two outside board seats are regarded as busy. The debt ratio is total debt scaled down by total assets. The EBIT ratio is earnings before interest and taxes divided by total assets. Board size is the total number of board members. Directors are classified as independent based on Baysinger and Butler (1985). * Statistically significant at the 10% level. ** Statistically significant at the 5% level. *** Statistically significant at the 1% level.

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One group represents those with fewer than two outside board seats or ‘‘non-busy” directors. The other group includes those who hold two or more outside directorships or ‘‘busy” directors. The cutoff point of two outside board seats (or three total board seats) may seem arbitrary, but it is selected for two reasons. First, to make the results comparable to those in prior studies, we utilize the same definition of ‘‘busy” directors as in Ferris et al. (2003), Fich and Shivdasani, (2006), Perry and Peyer (2005), and Core et al., 1999. Second, it reflects the recommendation by the CII that directors should sit on no more than two outside boards. Of the 41,475 observations, 31,074 are non-busy directors whereas 10,401 are considered busy. Table 2 Panel A displays the summary statistics for individual director characteristics. The average non-busy director is 59.12 years old, whereas the average busy director is 60.93, which is a small but statistically significant difference. Only 4% of the non-busy directors are minorities, while 9% of the busy directors are minorities. It appears that ethnic minorities hold a significantly higher number of outside board seats. This may reflect the recent call to place more minorities on the board. Female directors represent 9% of the non-busy directors and 12% of the busy directors. Again, this may be a sign that corporations have responded to the pressure to appoint more female directors. Independent outside directors constitute 61% of the non-busy directors and 78% of the busy directors. Not surprisingly, independent directors are more in demand because they are meant to provide more objective advice. In terms of equity ownership, the average non-busy director holds 1.53% of the equity ownership whereas the average ownership for the busy directors is only 0.54%, which is a significant difference. An important observation is the busy directors’ relatively lower ownership stake. In an agency framework, busy directors can afford to be busy as their private benefits of being on multiple outside boards may be greater than the value loss from not serving on the committees. This evidence seems to support the agency hypothesis where directors with low ownership supply their services to outside boards for their private benefits. Table 2 Panel B displays the summary statistics for selected firm characteristics. As far as firm size, firms with non-busy directors average $4536 and $5316 million in terms of sales and total assets, respectively. On the contrary, firms with busy directors are significantly larger with average sales and total assets of $9081 and $11,024 million respectively. This may indicate that directors of larger firms may have more expertise and are more sought-after in the market for corporate directors. The total debt ratio is significantly higher for firms with busy directors (48.33% vs. 45.47%). The average EBIT ratio (which proxies for profitability) is 7.67% for firms with less busy directors and 7.41% for firms with busier directors. The difference, however, is not significant. Table 2 Panel C exhibits the descriptive statistics for board characteristics. In terms of board size, non-busy directors sit on boards with 9.57 members on average. Busy directors, on the other hand, sit on boards with 10.47 directors on average. The difference is statistically significant. Busier directors tend to be on larger boards. As far as board composition, non-busy directors sit on boards where 63.75% of the directors are independent. Busy directors, on the contrary, are on boards where 70.24% of the members are independent. Thus, busier directors serve on boards that are significantly more independent. Finally, in terms of the number of internal board committees, non-busy directors serve on 1.25 internal committees whereas busy directors offer their service on 1.61 committees, which is a statistically significant difference. It appears that busy directors are more inclined to serve on more board committees. This is preliminary evidence in favor of the expertise/reputation hypothesis, which predicts that busy directors possess more

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expertise and experience and are more qualified to sit on more internal board committees. 5. Method and empirical evidence 5.1. Method To study the relation between the number of board committees in year t and the number of directorships in year t  1, we utilize 2SLS techniques specifically testing and correcting for endogeneity. Since directors do not hold the same number of committee memberships across different firms, we standardize the committee membership variable for each director in two different ways. The first way to achieve this standardization is to utilize the average number of committee memberships per director across all firms as the dependent variable. The second way (the results, not reported, are qualitatively similar to the ones achieved by the averaging approach) is to only use those observations where a director holds the same number of committee memberships across all firms on which she/he serves as a director. 5.2. Empirical results We present the results of Hausman’s endogeneity test in Eq. (2) of Table 3. It is evident that endogeneity is present. Thus, in Table 3 our estimates in Eq. (3) pertain to the 2SLS analysis relating the number of board committees in year t, to the predicted value of the number of directorships in year t  1 estimated in regression Eq. (1). We include several controls for director and firm characteristics. Eq. (3) shows that while the coefficient of the linear term of the lagged outside directorships is negative and significant, the quadratic term exhibits a positive and significant coefficient. The results suggest that while initially the greater number of outside directorships is related to a lower number of internal board committees, after a threshold a greater number of directorships is related to a higher number of committee memberships. Thus, while at lower levels of multiple board seats the busyness hypothesis seems to hold, at higher level of board seats, it is the reputation hypothesis that is supported by the evidence. To determine the threshold value, we differentiate Eq. (3) with respect to the lagged number of outside directorships and set the first derivative equal to zero. The result of the computation yields the number of outside board memberships at two as the reversal point. Hence, directors with a greater number of multiple board seats are likely to sit on a lesser number of internal board committees until the number of outside board seats reaches two. Then, each additional outside board seat associates with an increase in membership of internal board committees. The evidence seems to lend credence to both the reputation hypothesis and the busyness hypothesis.2 The busyness hypothesis is supported as long as the number of outside directorships does not exceed two. Beyond that, the reputation/expertise effect kicks in. 5.3. Control variables Examining the control variables in Eq. (3), we discover a number of interesting results. Senior directors, as proxied by their age, seem to serve on a larger number of committees. Perhaps this

2 Following the reviewer recommendation, we split the sample into two subsamples. The first and substantially larger subsample includes only those directors that are employees at other entities (N = 26449). The second subsample includes only the retired and professional directors (N = 1431). Results indicate that the support for busyness and reputation hypothesis is found only for the employed directors’ subsample. In fact, this subsample seems to drive the overall sample results.

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Table 3 Relation between the number of board committees and number of outside directorships Eq. (2) (Hausman test)

Eq. (3) (2-SLS)

(No. of board committees)t 1.715 (12.99)***

(No. of board committees)t 2.306 (11.31)***

Panel A: Director characteristics (No. of outside directorships)t1

–

[(No. of outside directorships)t1]2

–

0.563 (17.34)*** 0.022 (0.91) 0.119 (6.72)*** 1.068 (87.75)*** 0.013 (7.21) 0.0001 (5.23)***

0.598 (6.08)*** 0.213 (4.66)*** 0.058 (11.42)*** 0.661 (16.25)*** 0.065 (2.11)** 0.101 (5.6)*** 1.129 (52.47)*** 0.014 (8.02) 0.0001 (5.61)***

0.022 (5.16)*** 0.174 (6.19)*** 0.063 (2.14)**

0.057 (5.59)*** 0.217 (7.38)*** 0.026 (0.84)

0.025 (11.07)*** 0.003 (0.10) 0.06 (12.27)*** 0.301 27,880

0.024 (10.46)*** 0.106 (2.49)***

Dependent variable Intercept

(No. of board committees)t1 Ln (age) Minority (1 if minority) Gender (1 if female) Independent director (1 if independent) % Director’s equity ownership (% Director’s equity ownership)2 Panel B: Firm characteristics Ln (total assets) Debt ratio EBIT ratio Panel C: Board characteristics Board size % Independent Directors v Adjusted R2 N

0.309 27,880

This table presents results of tests of relation between the number of board committees in year t, (Ncommitteet1), and the predicted value of the number of outside   directorships in year t  1, (Noutdirect1;i ). Predicted value of (Noutdirect1;i ) is derived from the regression in Eq. (1) described below. For brevity, the regression results of  Eq. (1) are not reported in the table. Eq. (2) reports the Hausman test of endogeneity. Presence of endogeneity is indicated by the significant coefficient of v , which is the residual of the regression in Eq. (1). Eq. (3) presents the results of regression that relates number of board committees in year t, (Ncommitteet,i) to the predicted value of the number of outside directorships in year t  1obtained from Eq. (1). The three equations are as follows: 2

Noutdirect1;i ¼ a1 þ a2 LnðageÞt1;i þ a3 Minort1;i þ a4 Gendert1;i þ a5 Indepent1;i þ a6 Stkholdt1;i þ a7 Stkholdt1;i þ a8 LnðTAÞt1;i þ a9 Debtrt1;i þ a10 EBITrt1;i þ a11 Boardsizet1;i þ a12 Indepenpctt1;i þ V t1;i

ð1Þ 2

Ncommitteet1;i ¼ b1 þ b2 LnðageÞt1;i þ b3 Minort1;i þ b4 Gendert1;i þ b5 Indepent1;i þ b6 Stkholdt1;i þ b7 Stkholdt1;i þ b8 LnðTAÞt1;i þ b9 Debtrt1;i þ b10 EBITrt1;i þ b11 Boardsizet1;i þ b12 Indepenpctt1;i þ b13 V t1;i þ et1;i

ð2Þ

2

Ncommitteet;i ¼ c1 þ c2 Noutdirect1;i þ c3 Noutdirect1;i þ c4 LnðageÞt;i þ c5 Minort;i þ c6 Gendert;i þ c7 Indepent;i þ c8 Stkholdt;i þ c9 Stkholdt;i2 þ c10 LnðTAt;i Þ þ c11 Debtrt;i þ c12 EBITrt;i þ c13 Boardsizet;i þ c14 Indepenpctt;i þ lt;i

ð3Þ

where Ncommittee is the number of committees, Noutdirec is the number of outside directorships, Minor is dummy = 1 for minority, Gender is dummy = 1 if female, Indepen is Independent director dummy, Stkhold is the percentage of equity owned by the director, Ln (TA) is log of total assets, Debtr is defined as debt ratio = ratio of total debt to total assets, Boardsize is total number of board members, EBITr is defined as EBIT ratio = ratio of EBIT to total assets, and Indepenpct is the percentage of independent directors in the board. * Statistically significant at the 10% level. ** Statistically significant at the 5% level. *** Statistically significant at the 1% level.

variable also captures the experience and reputation effects that come with age. The minority dummy exhibits a significant positive coefficient, which suggests that minority directors are more likely to be on board committees than their Caucasian counterparts. Similarly, the gender dummy also bears a positive and significant coefficient, implying that female directors are likely to be placed on more board committees. This could reflect that minority directors

are given a larger role due to political pressure to promote ethnic and gender egalitarianism. The independent director dummy shows a significant positive coefficient. Independent directors are more likely to serve on internal board committees. This is intuitive. Many firms do not permit inside directors to serve on audit or compensation committees. We also include in Eq. (3) the percentage of equity owned by each

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director in linear and quadratic terms. Several studies find that ownership exhibits a non-linear relation with other variables (Morck et al., 1988; Schooley and Barney, 1994; among others). Interestingly, while the linear terms have a significant negative coefficient, the quadratic term of equity ownership bears a positive and significant coefficient. The evidence implies that low levels of ownership do not motivate directors to participate in more committee work. However, higher levels of ownership do. With respect to firm characteristics, firm size (measured by total assets) is positively related to the number of committee assignments. Directors in larger firms sit on more board committees. Perhaps larger firms require more managerial oversight, which causes directors to become more active in their committee work. In addition, directors in highly levered firms sit on more board committees. These firms may send lenders a signal of greater managerial oversight by making directors more active in their committee work. There seems to be no significant relation between performance (measured by EBIT ratio) and committee memberships. Finally, when we examine the board size effect, we find that the coefficient of board size is negative and significant. This is in agreement with the hypothesis that, given that smaller boards have fewer members, each member of a smaller board has to serves on more committees. With respect to board composition, the percentage of independent directors exhibits a positive and significant coefficient, which indicates that directors serve on more internal committees where the full board is more independent. Our interpretation is that greater board independence works as a complementary mechanism to committee membership for monitoring of management. 5.4. The role of regulation As argued previously, we expect that in regulated industries, directors will serve on larger number of committees due to lower agency problems. To test this conjecture, we estimate a 2SLS model that is similar in specification to the tests reported in Eq. (3) of Table 3 above, except that here we introduce a dummy variable = 1 for regulated and = 0 for unregulated industries. Financial and utility firms are included in the regulated sample.3 The rest of the firms in the sample are considered industrial (unregulated) firms. Table 4 displays the regression results of the second stage model. The main results for the sample are robust to change in the specification. The lagged number of outside directors shows a negative and significant coefficient whereas its quadratic term exhibits a positive and significant coefficient. As expected, the regulated industry dummy coefficient comes up as significant and positive. Hence, for regulated firms, on average, there are more committee memberships per director. 5.5. Individual committee memberships So far, we have examined the total number of committee memberships for each director. Recognizing that directors may not be equally interested in or be seen as qualified to serve on all of the committees, we look at each board committee individually. Also, different committees may have different workloads and skill requirements. For instance, membership in the compensation committee, audit committee, and corporate governance committee may not only involve specialized knowledge/financial expertise but may also require a greater time commitment. Alternatively, firm management may see certain directors as more knowledge-

3

SIC 6000-6999 for financial firms and SIC 4900-4999 for utilities.

Table 4 Relation between the number of board committees and the number of outside directorships for regulated industry Dependent variable

(No. of board committees)t (t-Statistics)

Intercept

2.286 (11.2)***

Panel A: Director characteristics (No. of outside directorships)t1

0.586 (5.95)*** 0.205 (4.48)*** 0.058 (11.4)*** 0.658 (16.18)*** 0.065 (2.11)*** 0.101 (5.57)*** 1.129 (52.45)*** 0.014 (7.97)*** 0.0001 (5.58)***

[(No. of outside directorships)t1]2 (No. of board committees)t1 Ln (age) Minority (1 if minority) Gender (1 if female) Independent director (1 if independent) % Director’s equity ownership (% Director’s equity ownership)2 Panel B: Firm characteristics Ln (total assets)

0.056 (5.49)*** 0.211 (7.14)*** 0.026 0.84

Debt ratio EBIT ratio Panel C: Board characteristics Board size

0.024 (10.55)*** 0.099 (2.32)** 0.029 (1.76)* 0.309 27,880

% Independent directors Regulated dummy Adjusted R2 N

This table presents results of tests of relation between the number of board committees in year t, (Ncommitteet,i) and the predicted value of the number of outside directorships in year t  1, (Noutdirect1;i ) derived from the regression in Eq. (1), as shown in Table 3 and not reported, as well as director and firm characteristics in year t, including a regulated industry dummy variable, Reg. 2

Ncommitteet;i ¼ c1 þ c2 Noutdirect1;i þ c3 Noutdirect1;i þ c4 LnðageÞt;i þ c5 Minort;i 2

þ c6 Gendert;i þ c7 Indepent;i þ c8 Stkholdt;i þ c9 Stkholdt1;i þ c10 LnðTAÞt;i þ c11 Debtrt;i þ c12 EBITrt;i þ c13 Boardsizet;i þ c14 Indepenpctt;i þ c15 Regt;i þ lt;i . . . where Ncommittee is the number of committees, Noutdirec is the number of outside directorships, Minor is dummy = 1 for minority, Gender is dummy = 1 if female, Indepen is Independent director dummy, Stkhold is the percentage of equity owned by the director, Debtr is defined as debt ratio = ratio of total debt to total assets, Boardsize is total number of board members, EBITr is defined as EBIT ratio = ratio of EBIT to total assets, and Indepenpct is the percentage of independent directors in the board, Reg is dummy variable = 1 for regulated industry firms. * Statistically significant at the 10% level. ** Statistically significant at the 5% level. *** Statistically significant at the 1% level.

able and experienced, and/or they may be more willing and able to devote a greater amount of time to these specific matters. Firms may then nominate these individuals to the appropriate committee(s). One may expect that busy directors are less likely to be nominated to these committees unless their busyness reflects greater expertise and reputation in their field. Thus, we expect either a negative or a U-shaped relation between the likelihood of serving on these committees and multiple board seats.

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Table 5 Predicting various committee memberships with the number of outside directorships Dependent variable

Model 1 (Wald-statistics) Compensation committee

Model 2 (Wald-statistics) Audit committee

Model 3 (Wald-statistics) Nominating committee

Model 4 (Wald-statistics) Corporate governance committee

Intercept

0.001 (0.98)

0.001 (2.95)*

0.001 (1.99)

0.001 (1.00)

1.429 (39.83)*** 0.059 (0.22) 0.203 (38.58)*** 0.702 (97.91)*** 0.158 (12.12)*** 2.077 (1729.72)*** 0.008 (8.04)***

0.849 (14.54)*** 0.199 (2.56) 0.158 (23.02)*** 0.168 (5.90)** 0.205 (20.26)*** 2.131 (1826.66)*** 0.057 (125.47)***

1.283 (42.10)*** 0.649 (32.74)*** 0.277 (90.36)*** 0.012 (0.04) 0.044 (1.05) 0.093 (4.82)** 0.007 (11.69)***

2.834 (65.70)*** 0.721 (15.28)*** 1.27 (787.54)*** 0.145 (3.48)* 0.275 (27.73)*** 0.352 (31.52)*** 0.005 (1.24)

0.136 (51.13)*** 0.047 (0.38) 0.258 (10.51)***

0.059 (9.49)*** 0.024 (0.10) 0.079 (0.98)

0.095 (31.10)*** 0.226 (11.16)*** 0.23 (9.45)***

0.071 (8.77)*** 0.048 (0.23) 0.767 (35.10)***

0.101 (268.53)*** 2.177 (527.26)*** 5154***

0.109 (308.86)*** 1.904 (406.76)*** 5139***

0.037 (45.56)*** 0.695 (69.61)*** 1773***

0.066 (74.83)*** 2.331 (330.32)*** 8337***

Panel A: Director characteristics (No. of outside directorships)t1 [(No. of outside directorships)t1]2 Ln (age) Minority (1 if minority) Gender (1 if female) Independent director (1 if independent) % Director’s equity ownership Panel B: Firm characteristics Ln (total assets) Debt ratio EBIT ratio Panel C: Board characteristics Board size % Independent directors

v2

This table presents results of tests predicting membership in various board committees in year t, using the predicted value of the number of outside directorships in year  t  1, (Noutdirect1;i ), as well as director and firm characteristics in year t.

Committee MembershipðYes ¼ 1; No ¼ 0Þ 2

¼ c1 þ c2 Noutdirect1;i þ c3 Noutdirect1;i þ c4 LnðageÞt;i þ c5 Minort;i þ c6 Gendert;i þ c7 Indepent;i þ c8 Stkholdt;i þ c9 LnðTAÞt;i þ c10 Debtrt;i þ c11 EBITrt;i þ c12 Boardsizet;i þ c13 Indepenpctt;i þ lt;i where Ncommittee is the number of committees, Noutdirec is the number of outside directorships, Minor is dummy = 1 for minority, Gender is dummy = 1 if female, Indepen is Independent director dummy, Stkhold is the percentage of equity owned by the director, Debtr is defined as debt ratio = ratio of total debt to total assets, Boardsize is total number of board members, EBITr is defined as EBIT ratio = ratio of EBIT to total assets, and Indeppct is the percentage of independent directors in the board. * Statistically significant at the 10% level. ** Statistically significant at the 5% level. *** Statistically significant at the 1% level.

In contrast, membership on the nominating committee may require different skills such as networking. The more a director is networked—evidenced by being on a greater number of boards— the more likely she/he would contribute to board nominations. Here, one may expect a positive relation (at least up to a certain level) beyond which the director then becomes too busy. Thus, we may expect a linear positive or inverted U-shape relation between the likelihood of serving on the nominating committee and director busyness. To determine the likelihood for a director to be on a specific committee, we conduct a logistic regression analysis where the dependent variable is equal to one if the director serves on a given committee and zero otherwise. The results of the logistic regressions are displayed in Table 5. The results show that for the compensation and audit committees the coefficient of director busyness is significantly negative indicating that busy directors are either not willing to or are not encouraged by firms to serve on these two committees. Thus, the busyness hypothesis seems supported when looking at the compensation and audit committees. Perhaps the responsibilities of these committees are more demanding as they require financial expertise and a greater time commitment.

For the nominating committee, an inverted U-shaped relation holds. Here, up to a certain point, busy directors are more likely to serve on the nominating committee and once a threshold is reached their likelihood to serve on this committee declines. For the corporate governance committee, the relation is U-shaped. This implies that, while initially with increasing busyness the likelihood of serving on governance committee declines, beyond a certain point this likelihood increases with busyness. 5.6. The impact of the Sarbanes–Oxley act Several corporate governance mechanisms have been affected by the enactment of the Sarbanes–Oxley act of 2002. To ascertain the impact of this Act, we segregate the sample into pre- and post-Sarbanes–Oxley. Since the Act was passed in late 2002, we construct two subsamples, one before 2002 and one after. Table 6 shows the result of the regression analysis. The results in Eq. (1) indicate that in the pre-Sarbanes–Oxley period the nonlinear U-shaped relation between multiple board seats and committee memberships (as previously reported for the whole sample) holds. For the post-Sarbanes–Oxley period, Eq. (2) results indicate that while the negative coefficient of linear term in board seats remains

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P. Jiraporn et al. / Journal of Banking & Finance 33 (2009) 819–828 Table 6 Relation between board seats and committee memberships: pre- and post-Sarbanes–Oxley Model 1 (t-Statistics) (No. of board committees)t Pre-Sarbanes–Oxley

Dependent variable Intercept Panel A: Director Characteristics (No. of outside directorships)t1 [(No. of outside directorships)t1]2 (No. of board committees)t1 Ln (Age) Minority (1 if minority) Gender (1 if female) Independent director (1 if independent) % Director’s equity ownership (% Director’s equity ownership)2 Panel B: Firm characteristics Ln (total assets) Debt ratio EBIT ratio Panel C: Board characteristics Board size 2

Adjusted R N

Model 2 (t-Statistics) (No. of board committees)t Post-Sarbanes–Oxley

1.287 (3.92)***

2.228 (6.04)***

0.384 (2.76)*** 0.401 (5.5)*** 0.057 (5.55)*** 0.477 (6.71)*** 0.11 (1.98)** 0.102 (2.85)*** 0.925 (22.24)*** 0.012 (3.48)*** 0.0001 (3.17)***

0.384 (2.11)*** 0.083 (0.77) 0.052 (5.12)*** 0.69 (8.62)*** 0.067 (1.06) 0.154 (4.13)*** 1.198 (27.43)*** 0.02 (4.57)*** 0.0001 (2.59)***

0 (0.01) 0.184 (3.42)*** 0.362 (3.64)***

0.047 (2.11)** 0.187 (2.75)*** 0.052 (0.67)

0.019 (4.51)*** 0.296 6958

0.035 (6.53)*** 0.311 6668

This table presents results of tests of relation between the number of board committees in year t, (Ncommitteet,) and the predicted value of the number of outside  directorships in year t  1, (Noutdirect1;i ), as well as director and firm characteristics in year t. 



2

Ncommitteet;i ¼ c1 þ c2 Noutdirect1;i þ c3 Noutdirec2t1;i þ c4 LnðageÞt;i þ c5 Minort;i þ c6 Gendert;i þ c7 Indepent;i þ c8 Stkholdt;i þ c9 Stkholdt1;i þ c10 LnðTAÞt;i þ c11 Debtrt;i þ c12 EBITrt;i þ c13 Boardsizet;i þ c14 Indepenpctt;i þ lt;i where Ncommittee is the number of committees, Noutdirec is the number of outside directorships, Minor is dummy = 1 for minority, Gender is dummy = 1 if female, Indepen is Independent director dummy, Stkhold is the percentage of equity owned by the director, Debtr is defined as debt ratio = ratio of total debt to total assets, Boardsize is total number of board members, EBITr is defined as EBIT ratio = ratio of EBIT to total assets, and Indeppct is the percentage of independent directors in the board. * Statistically significant at the 10% level. ** Statistically significant at the 5% level. *** Statistically significant at the 1% level.

significant at 5% level, the coefficient of quadratic term becomes insignificant. Thus, the relation between committee memberships and board seats seems to turn negative in the post-Sarbanes–Oxley era. The post-Sarbanes–Oxley results can be interpreted as supportive of busyness hypothesis in that a larger number of board seats associates with fewer committee assignments. We interpret this as indicating that either the sample firms became more conservative in assigning committee memberships to overly busy directors or that busy directors chose to serve on fewer committees in the post-Sarbanes–Oxley periods due to the increased accountability standards. It appears that the Sarbanes–Oxley act had material impact on the association between the number of multiple board seats and the committee memberships. 6. Conclusions The primary purpose of this study is to enhance our understanding of the board busyness-corporate performance link. We try to ascertain if multiple directorships adversely impact board

committee memberships and thereby dilute board members’ ability to add value through monitoring and advisory services. In support of the busyness hypothesis, the empirical evidence suggests that, at lower levels of multiple board seats, directors holding more board seats tend to serve on fewer board committees. At higher levels of multiple board seats, the reputation hypothesis seems to be supported in that busy directors serve on a higher number of committees. To the extent the busyness hypothesis gets supported, our results suggest that a lack of committee work involvement may be a possible cause of the reported (Fich and Shivdasani, 2006) negative value consequences of multiple board memberships. The secondary objective of this study is to shed light on various other factors that may impact the number of internal board committees directors serve on. We obtain several interesting results. First, we find that minority directors hold a larger number of board committee memberships. Second, and as expected, independent directors tend to serve on more internal board committees. Third, only when the ownership stakes are higher does the directors’

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