Interview: The Connection Between Powerful Independent Directors and Shareholder Valuations

Corporate Governance Insights Interview Series: Top corporate governance experts report on the latest research in emerging markets.


Randall Morck is Jarislowsky Distinguished Professor of Finance School of Business at the University of Alberta and aresearch associate with the National Bureau of Economic Research in Cambridge, Massachusetts. Areas of research interest include corporate governance, executive compensation and behavioral finance.

The most interesting piece on corporate governance in emerging markets I read recently is…

… A fascinating two-volume series, The Origins of Political Order and Political Order and Political Decay, by Francis Fukuyama. The books drive home how incredibly hard it is for countries to instil the rule of law and rid themselves of widespread and systemic corruption. He looks at how the United States conquered the robber barons and how Great Britain got the aristocracy under control, and demonstrates that this takes generations and massive reform. After reading these books, I have a newfound respect for emerging markets that are making progress on rule of law, like Colombia. This was a country formerly known for the drug lords that operated at will, completely outside the law. Now, it seems they are transcending this legacy to become more like Costa Rica, where there is a stronger sense of rule of law.

Right now I am working on…

… An extension of my earlier research that reveals a significant and positive correlation between better company valuation and the presence of high-powered independent directors in the US. For purposes of the study, power is defined by the strength of the resume and the connectivity of the individuals to others of equal stature.
In the US study, we look at sudden deaths of powerful independent directors to see whether the presence of these powerful independent directors is what boosts share valuations or if they simply tend to join the boards of firms whose share prices are already high. We find that such sudden death events immediately and significantly reduce shareholder value, thereby concluding that it is their presence that influences share valuations.  We also find that more powerful independent directors are associated with fewer value-destroying acquisitions, less free cash flow retention, more accountability for poor performance, and less earnings manipulation.

There are two reasons for this outcome. The first is that power gives you freedom to act.  A prominent, well-connected individual is not dependent on the board position or on the CEO who may have done a favor for you. So, if the CEO is doing something misguided, you can speak out. Conversely, if you are reliant in some way, you aren’t likely to challenge the CEO who is about to make a really bad decision, like an ill-conceived acquisition that only serves the CEO’s ego.

The second reason is that by virtue of their own social networks of other equally powerful, successful, and connected people, powerful independent directors have access to a wider knowledge base that can contribute to more informed strategic decision making.

My ongoing research will explore this issue as it relates to emerging markets, starting with China.

For emerging markets, powerful independent directors may not be the force for good governance we see in the US…

… Because there’s a fundamental difference in emerging markets compared to developed economies, which is that corruption is a much bigger problem.  In many emerging markets you typically have a small core of wealthy families who each control huge groups of big businesses.  Often, they are part of a political elite. This can create a sense of invincibility and being above the law.

If the power of the independent directors in those countries comes from connections with other wealthy families or the political elite, then it might only reinforce the notion of being above the law.

And where corruption is an accepted part of overall business and political environment, and the wealthy business elite act as if they are above the law, the presence of independent directors who are part of this same elite power circle might actually adversely affect public shareholder valuations, especially if power shifts suddenly. Look at what happened in Indonesia when President Suharto fell out of power. Suharto’s government was characterized by widespread corruption and excess family influence.  When his regime was toppled, the companies that took the biggest hit were those with the strongest ties to the Suharto family, as shown by Professor Raymond Fisman’s study.

More importantly, if the higher shareholder valuations reflect corruption money rather than better management, then the link between higher shareholder valuations and a more efficient economy breaks down.

I think the most relevant CG research topic for emerging markets now is…

…. Reducing systemic corruption and improving adherence to the rule of law. Until the broader corruption and rule-of-law issues are addressed, other company-level corporate governance-related improvements really won’t make much of a difference.  These changes are going to take a long time and a lot of hard work.

As I mentioned, I do think some countries are starting to think about this in a more serious way. For example, in South Korea we are seeing more resistance to this notion of entitlement and being above the law. The recent incident in which the daughter of the controlling owner of a huge group of big businesses—including the airline at which she was an executive—threw a temper tantrum upon being served nuts in a package rather than on a plate, seems to be drawing more attention there than it might once have.

For further reading, Professor Morck recommends:

Fisman, David, Ray Fisman, Julia Galef, Rakesh Khurana, and Yongxiang Wang. “Estimating the Value of Connections to Vice-President Cheney” (2012) B.E. Journal of Economic Analysis & Policy, Advances

Yermack, David, “Flights of Fancy: Corporate Jets, CEO Perquisites, and Inferior Shareholder Returns” (April 2006) Journal of Financial Economics


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