1. Are All Inside Directors the Same
Are All Inside Directors the Same? CEO Entrenchment or Board Enhancement
Ronald Masulis and Shawn Mobbs
Vanderbilt University & The University of Alabama

2. Background and Motivation
Governance reforms emphasize outside directors
Sarbanes-Oxley, Exchange Listings, Institutional Investors
Pressured firms to decrease insider representation
Little research on the role of inside directors
Extensive board structure research- focuses on outside directors
Two opposing theories of the role of inside directors
Evidence of greater CEO influence
Valuable contributors of firm-specific information
Fama and Jensen (1983), Harris and Raviv (2008), Raheja (2005)
Coles et al. (2008), Klein (1998)
Can we distinguish between the two?

3. Related Literature and Research Question
Outside directors differ in degrees of independence
Mace (1971), Hallock (1997), Core et al (1999), Shivdasani and Yermack (1999), Hermalin and Weisbach (2003)
External labor market for directorships
Valuable decision management and control skills: Fama and Jensen (1983), Brickley, Linck and Coles (1999), Kaplan and Reishsus (1990)
Inside directors’ differ in degrees of independence
Independent Inside Directors – hold outside directorships
Indicates valuable decision management and control skills
Greater career opportunities apart from their current CEO
Are independent inside directors (IIDs) valuable board members?

4. Inside Director Hypotheses
Agency Perspective: Inside directors aid CEO entrenchment and extraction of private benefits of control H1 Inside directors with outside directorships (independent inside directors), are predicted to be more common in firms with less powerful or less entrenched CEOs. H2 Boards with independent inside directors are better informed and have stronger more talented inside directors. Thus, these firms should have better firm performance and stock valuation.

5. Inside Director Hypotheses
Optimal Board Perspective: Advisory roles of inside directors enhance board decision making, which is especially important when major decisions must be made. H3 Non-CEO inside directors are predicted to be more common and to enhance firm value when Information Importance is high; specifically in firms with one or more of the following attributes (1) high growth opportunities, (2) a large, complex organizational structure and (3) highly competitive product markets. Independent inside directors are predicted to be especially valuable and frequent due to their greater independence and market recognition of their superior skills. H4 Inside directors are more valuable and more frequent when outside directors have substantial board power, such as when (1) the chairman of the board is not the CEO or (2) the board includes a large majority of independent outside directors, since there is a greater need for firm- specific knowledge in either case. Independent inside directors should be especially frequent and lead to greater firm performance in such firms.

6. Data IRRC Data ~ S&P 1500 firms; 1997-2003 (Panel Data) Exclude
Finance and Utility Firms
Firms where CEO≥64 years old; Hermalin and Weisbach (1988)
Final Sample:
Director observations
6,371 non-CEO inside directors
11% are IIDs
Firms: 1,987
9% have one or more IIDs

7. Determinants of Inside Directors
Firm Characteristics – Boone et al. (2007), Linck et al. (2008), Coles et al. (2008), Denis and Sarin (1999)
Size, R&D, Capital Expenditures, Leverage, Business & Geographic Segments
Past Performance, M&A
CEO Influence
Tenure, Age, Ownership, Founder or Relative is active in firm
SOX Influence
Methodology: Multivariate OLS, Tobit and Logit regressions
Industry fixed effects
Robust standard errors clustered by firm

8. Table 3. Determinants of Inside Directors
continued…

9. Table 3. Determinants of Inside Directors
There are differences among inside directors
Independent inside directors are more likely where theory predicts insiders to bring the most value

10. Inside Directors and Firm Performance
Decision to have non-CEO inside directors is not random
Heckman (1979) – Self-Selection Model
1st stage – Probit model (Table 3 Model 3)
Compute Inverse Mills Ratio
Identification and IV - SOX indicator (exogenous shock)
2nd stage – Regression of performance measure
Firms with inside directors
Inverse Mills Ratio – control for private information
Industry fixed effects, robust standard errors
Controls follow Coles et al. (2006), Anderson and Reeb (2003), Fich and Shivdasani (2006)
Firm Size, Business Segments, Firm Age
CEO & Board Ownership, Presence of Founder or Family member
Growth Opportunities, Return Volatility

11. Table 4. Firm Performance Regressions
Firm Performance Measures
Industry Adjusted Operating Performance (CF)
Industry Adjusted Ln(M/B) .
Controls

12. Table 5. Performance Regressions & Undiscovered Independent Inside Directors
Outside directorships are a signal of talented executives
Acquiring an outside directorships is associated with improved M/B – less agency costs (more CEO independence)

13. CEO Entrenchment
Greater CEO influence (tenure, ownership, duality) may hinder IIDs association with performance.
Underperforming firms may get more independent directors due to increased shareholder pressure.

14. Table 7. Performance Regressions: Firms with highly entrenched CEOs
IIDs have a stronger association with firm performance and value when the CEO is less entrenched
Non-IIDs may be an alternative means for CEOs to entrench themselves

15. Information Importance
Growth Opportunities
R&D, Capital Expenditures, High Tech Industry
Complex firms
Size, Business Segments, Geographic Reach, Firm Age
Competition
Board composition
Greater outside representation
Separate CEO and Chair

16. Table 8A. High R&D Activity
Differences are significant at 1% level
Differences are significant at 5% level
Strongest effect is in High R&D

17. Table 8B. Performance & Organizational Complexity
Principal Component Analysis
Firm size
Business segments
Geographic reach
Firm age
Organizational Complexity Factor Score

18. Table 8C. Performance Regressions: Firms in Highly Competitive Industries
When survival is most critical, independent inside directors are most valuable!

19. Board Monitoring Mechanisms
“…unless boards are given better access to information, simply increasing board [outside] independence is not sufficient to improve governance.”
Adams and Ferreira (2007)

20. Table 9. Performance Regressions & Board Monitoring Mechanisms
Greater outside representation alone may not be sufficient!
Independent inside directors appear more important than independent outside directors!

21. Table 14. CARs: Announcements of Outside Directorship Appointments
Event Study
Direct test of shareholder wealth impact
Directorship appointments must be to unaffiliated firms
3-day CAR based on a one factor market model
Panel A:
98 Announcements of Independent appointments
Mean CAR: 1.07%** Median CAR: .6%***

22. Table 15. CARs: Announcements of Departures of Independent Insiders
Panel A: Valuable Independent Inside directors
Examine Departures
123 Announcements
CARs
Mean: -1.1%***
Median: -.6%*
Sub-samples
No Successor mentioned -1%
Retirement departure -.8%
Leaving for another firm -2.6%
Post SOX %
Panel B: Dependent Inside Director Departures
No significant effect, but generally positive in sign

23. Robustness Alternative IID measure: IID indicator Outlier Adjustments
Median regressions
Winsorize data at 1% and 99% levels
Endogeneity
Self-Selection of inside directors (undiscovered IIDs)
Treatment model (non-CEO inside directors)
2SLS IV regressions (IVs: SOX Indicator and CEO tenure)
Firm Fixed Effects
Qualitative results are invariant!

24. Conclusions
Non-CEO Inside directors are heterogeneous and independent insiders can often increase firm value
Outside directorships is one important mechanism for distinguishing inside directors who are more valuable to the board and shareholders
Taking into account differences among inside directors and among firms can be important in:
Future research on corporate boards
Policy/governance reforms
Inside directors are valuable to information intensive firms
IIDs are more valuable than non-IIDs
Independent inside directors can be as important as “independent” outside directors!

25. Thank you