Multiple Directorships and Corporate Misconduct: The Moderating Influences of Board Size and outside Directors

By Schnake, Mel E.; Williams, Robert J. | Journal of Business Strategies, Spring 2008 | Go to article overview

Multiple Directorships and Corporate Misconduct: The Moderating Influences of Board Size and outside Directors


Schnake, Mel E., Williams, Robert J., Journal of Business Strategies


Abstract

This study examined the possible impact of both board size and the proportion of outside directors on the link between directors holding multiple directorships and firm misconduct. The study utilized a sample of 181 firms drawn from the financial services sector during the 1999-2003 time period. The results suggest that among those firms whose directors hold multiple directorships, the incidence of 10K investigations initiated against those firms is significantly less in those firms having smaller boards. The results offer further evidence that smaller boards might be better monitors of their firms' behavior than larger boards. Further, contrary to theory, no significant relationship was observed between proportion of outside directors, multiple directorships and the incidence of 10K investigations. The implications of the findings and areas for future research are discussed.

Background

There is an on-going debate within the area of corporate governance regarding the membership of directors on multiple boards and its potential impact on effective firm monitoring. In light of the recent scandals involving firms such as Enron, Worldcom, and Tyco, effective corporate governance is seen by institutional investors and shareholder activists to be extremely important. While researchers have examined various governance issues, the potential consequence of multiple board membership by directors on monitoring their firms remains largely unexplored (Ferris, Jagannathan & Pritchard, 2003).

Multiple Directorships and Director Distraction

There is some debate as to whether the service of directors on multiple boards will serve to either bolster or hinder proper firm monitoring, and serve to prevent firm misbehavior. Some favor multiple directorships, arguing that firms can obtain valuable resources and vital information through board interlocks (Business Roundtable, 1997; Schnake, Fredenberger & Williams, 2005; Zahra & Pearce, 1989).

There is some evidence that board interlocks may be linked with effective capital acquisition (Mizruchi & Stearns, 1988; Steams & Mizruchi, 1993). A board whose members serve on several other boards may enable the firm to gain access to needed resources and critical information through these multiple directorships (Bhagat & Black, 1999; Zahra & Pearce, 1989). Interlocked directors may be able to observe investigations and legal proceedings brought against other firms on whose boards they serve. Directors can then bring that vital information back to the other boards on which they serve, enabling these firms to take action to avoid similar legal pitfalls and litigation (Schnake et al., 2005).

On the other hand, there appears to be a dominant belief among institutional investors and governance activists that, given their limited time and cognitive abilities, service on multiple boards may result in board members becoming distracted, and may reduce their abilities to effectively monitor their firms (Ferris et al., 2003; Lipton & Lorsch, 1992). Through their service on several boards, directors may serve on fewer board committees and, therefore, may simply be too busy to properly monitor their firms (Ferris et al., 2003). Thus, any informational advantages gained through service on other boards may be lost due to director distraction caused by being too busy and being spread too thinly.

Further, it is likely that directors who serve on multiple boards may serve on firms in different industry settings. Having to face different industrial scenarios, the result is a greater demand on the director's cognitive abilities and more distraction for the director (Schnake et al., 2005). This notion of director distraction is often termed the "busyness hypothesis," and is linked by some to improper board oversight and its consequences.

The Council of Institutional Investors takes a position in line with the busyness hypothesis. …

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