Renee Adams et al, The Changing Nature of Corporate Board Activity Jeff Gordon discussion GCGC June 2015

Novel focus: Committee Structure of the Board Many papers have examined board structure from perspective of director independence or split of ceo/chair This paper specifically focuses on committee structure -- Not just identifying committees/tallying on firm basis Instead: trying to assess impact of committee structure on firm performance generally and also with respect to specific moments like m&a and ceo turnover 6/6/2015GCGC2

Novel focus Data collection problem: Adams et al want not only list of committees but some measure of committee activities, reflected in frequency of committee meeting Information on frequency of meetings of entire board and each committee is contained in the proxy statements To create extensive data base across the sweep of public firms over many years would be the work of many lifetimes, or one cleverly programmed computer This paper proudly says, we are not hand-coded 6/6/2015GCGC3

Deeper Agenda Adams et al note the transformation of the Board in two dimensions: from a Committee of the Whole to a Committee of Committees; From a mixed group of insiders, affiliates, and independents, to almost exclusively independents Although they acknowledge prior reform efforts, they regard the accelerant for this transformation to be the governance earthquake of SOX, focusing on the audit committee, and the subsequent stock exchange listing requirements, which added the mandate for a compensation committee and a nominating committee comprised solely of independent directors for non- controlled firms 6/6/2015GCGC4

Deeper Agenda So in evaluating the impact of committee function, Adams et al claim an alternative way to evaluate the SOX-era reform wave 6/6/2015GCGC5

Novel focus What is the key variable to measure the importance of this structural change to boards: Committee Focus Which is the average director’s percent of total meetings (full board + committee meetings) spent in committee meetings In interaction with Number of Board Meetings 6/6/2015GCGC6

Adams et al’s Conclusion Committee Focus x Board Meetings is inversely related to Tobin’s Q -- greater director engagement through committees reduces the value of the firm Moreover, Committee Focus is inversely related to acquiror returns upon merger announcement, and is inversely related to the chance that those announcement returns will be positive And Committee Focus impedes the process of CEO turnover 6/6/2015GCGC7

Why One Might Have Skepticism What’s the structural model whereby an increase in independent directors is positively associated with an increase in firm value and with an increase in meetings leading to CEO turnover (both shown) and yet an increase in committee involvement produces, at the same time, a negative result? 6/6/2015GCGC8

Various theories of board fragmentation Board by committee: – Delegation of previous management function to board committee – exec comp – director succession – control over audit proces – Delegation of full board function to board committee – Less common (except “special committee”) Eg, executive committee, a commonplace feature of large public firms is becoming less frequently and less frequently used -- 6/6/2015GCGC9

Board by Committee More focused activity by small groups, so more effective Independent directors working together without management develop greater sense of independence The committee functions of the Corporate Reform agenda do not seem in derogation of full board function Seems not to be preconditions for “functional team structures [that] are less able to cope in challenging environments than flat team structures in which team members share responsibilities.” (p.6) 6/6/2015GCGC10

Skepticism? The results may be driven by unusual firms where an increase in Committee Focus – meaning, heightened activity in “monitoring committees” is because of trouble in the firm -- Table 2, Summary statistics: median board meetings + committee meetings annually: 12, including 5.4 committee meetings. +/- 2 committee meetings covers the variation between 25 th & 75 th percentiles. Could a small numerical difference in committee meetings make a real difference? But: 95 th percentile, 12.4 committee meetings, 14 board meetings. Is that where the action is? 6/6/2015GCGC11

Heterogeneity across the sample As many as 3000 firms in the sample for a given year, from s&p 100 to microcap Adams et al flattens the diversity Eg, Lynck, Netter, & Yang, The determinants of Board Structure 2008 JFE, reports on a similar sized sample but broken down into small, medium, and large firms. Adams et al, reporting averages, say the number of directors has remained roughly constant. Lynck et al report that board size initially for large firms in the 1990s, but reversed after the early 2000s reform. Small firms board size remained unchanged. Large boards had median 10 directors; small, 6.0; medium, 7.0 The median number of board committees across the full is 3, which means “ANC,” quite different from large firms, median 5 (for the Dow Jones firms as of 2008) The fragmentation of these boards is simply different 6/6/2015GCGC12

Heterogeneity For the S&P 500, most firms had already adopted ANC Committees well before the early 2000s reforms. Pressures to add audit committees beginning in the late 1970s; Independent comp Committees were a product of the 1992 exec comp reform. Independence requirements strengthened but a substantial fraction of S&P 500 boards were predominantly independent before SOX etc. Compare: firms that need to make major adjustment before/after the 2000s reforms 6/6/2015GCGC13

Heterogeneity Controlled firms, per the stock exchange listing requirements, are not subject to the majority independent director requirement for the full board, though committee independence rules apply Omission of ownership data. Surely will have significant effect on board function and outcomes. Needs to be controlled for at very least. 6/6/2015GCGC14

Basic Strategy Common belief among economists and legal academics that “one size” may not fit all Therefore, instead of empirical approach that controls for differences in the sample – size; industry; age; ownership – these variables should be interacted with the institutional features and ought to be the subject of the analysis 6/6/2015GCGC15

Basic strategy Irony: Effect of reforms was to eliminate cross- sectional variation. So therefore find a variable, Committee Focus, which does vary, and make the subject of analysis. Alternative: see how the mandatory rule has differential effects across subsamples – ask whether “one size” ill-fits some 6/6/2015GCGC16

Regret Motivation for the paper: “Although board became more independent and expanded their committee duties following [the 2000s reforms], many still blamed them for the financial crisis of ” Yet: “The sample excludes firms in the financial services and utilities sectors. The structure of boards and committees in financial services firms differs greatly from those in other industries. Financial services conglomerates often contain separate boards of directors for each subsidiary bank.” 6/6/2015GCGC17

Regret So – I don’t think the multiple boards problem for financial firms is real where, as typical, the parent owns 100% of the subsidiary. The directors are insiders. (Charlie can correct me.) But: the place where governance really failed we can’t investigate, even though among the predominant solution is, guess what, a new board committee. And more: based on the prior uses of the governance literature with respect to banks, a study such as this that eschews application to financial firms will be used nevertheless in the debate about why governance failed in financial firms and what should be done. 6/6/2015GCGC18