Lead Independent Directors: Good
Governance or Window Dressing?
Phillip Lamoreaux
Arizona State University
Lubomir P. Litov
University of Arizona
Landon Mauler
Florida State University
Research Questions:
• What factors influence the choice to appoint a Lead Independent
Director (LID) on a board?
• Is the LID an effective corporate governance mechanism?
• What board characteristics influence the LID effectiveness?
Empirical Findings:
• Lead independent directors are associated with higher firm value, higher
excess returns, increased CEO turnover, and stronger CEO risk-taking
compensation incentives.
• Evidence suggests LIDs are more effective on large boards or busy
boards.
What is a Lead Independent Director?
• A separate board position (in corporate charter or bylaws).
• Responsibilities include, among others, ability to call board meetings, review
board meeting agendas, CEO retention and compensation, investor relations,
chairing non-management meetings.
• The position is intended, in part, to elevate the prominence of the
independent directors.
• Aimed to improve coordination among independent directors and to serve as
liaison with the CEO and with the Board Chairman.
Albertsons, Inc.
Lead Director
• Annually, at its June Board meeting, the Board appoints a Lead Director
responsible for, among other duties, coordinating the activities of the
independent directors, providing the Chairman of the Board with input on
agendas and Board and committee meetings and facilitating communications
between the Chairman of the Board and the other members of the Board.
Mr. Paul Corddry currently serves as the Lead Director.
AET – Aetna, Inc.
• Michael H. Jordan, an independent Director, currently is the Presiding Director.
Generally, the Presiding Director is responsible for coordinating the activities of
the independent Directors. Among other things, the Presiding Director sets the
agenda for and leads the non-management and independent Director sessions
held by the Board regularly, and briefs the Chairman and Chief Executive
Officer on any issues arising from those sessions. The Presiding Director also
acts as the principal liaison to the Chairman and Chief Executive Officer for the
views, and any concerns and issues, of the independent Directors, though all
Directors continue to interact one-on-one with the Chairman and Chief
Executive Officer, as needed and as appropriate. The Chairman and Chief
Executive Officer consults with the Presiding Director for input in setting the
agenda for Board meetings and the Board meeting schedule. The Presiding
Director also consults with the other Directors and advises the Chairman about
the quality, quantity and timeliness of information provided to the Board and the
Board’s decision-making processes.
Background:
• Prior work has pointed out to the need of advocates for independent directors
on the board:
• “If independent directors are to be effective, they need some form of leadership from among their own
numbers.” (Lipton and Lorsch, 1992)
• Lipton and Lorsch (1992) stress such need in companies with executive chairman or CEOboard chairman.
• In 1994, GM is the first U.S. public firm to adopt such board position.
• Soon after, institutional investors seize the idea of independent board leadership &
promote to other companies.
• SOX 2002, mandated independence of the audit committee, followed by rules
of listing exchanges that independent directors meet separately from insiders
or executives (NYSE 2003 Governance Rules).
Background:
• SEC has acknowledged LID position in new proxy rules effective
February 28, 2010
• “whether and why the company has a lead independent director, as well as the
specific role the lead independent director plays in the leadership of the
company.”
• “to provide more transparency about the company’s corporate governance, but
are not intended to influence a company’s decision regarding board leadership
structure.”
Motivation:
• The incidence of such appointments have drastically increased post NYSE
Corporate Governance rules release in 2003.
• We find 915 firms among firms reporting data in ExecuComp & Board Ex, in
2008, had an (LID).
• Concerns exist with the effectiveness of LIDs and their true independence
from management.
• Although the presence of LIDs is fairly common, limited academic research
on the impact of LIDs on firm valuation and corporate policies.
Contributions:
• First to examine the determinants, as well as effects, of Lead
Independent Directors
• Specifically in terms of market valuation, performance, CEO turnover, and CEO
incentives.
• Increase understanding of how LIDs enhance board performance
• Results indicate LIDs have a greater effect when
• Boards are very large.
• Directors are very busy.
Independent Directors:
• Board of directors serve, in part, to reduce agency costs of a CEO.
• Chhaochharia and Grinstein (2009): find board performance improves for firms
affected by SOX board independence requirements.
• Brickley, Coles, Jarrell (1997) discuss costs and benefits of CEO-Chairman duality.
• Yermack (1996): board size is inversely related to firm value.
• Fich and Shivdasani (2006): busy outside directors ineffective corporate monitors.
LID and Board Effectiveness:
• LIDs can enhance effectiveness of the board
• better board meeting planning.
• Improved communication among independent directors and executives.
• “Having a lead director energizes directors’ engagement and understanding of
the company and the issues it faces. The lead director also helps to raise the
quality of the materials received by directors before board meetings… directors
are able to ask better questions.” (SpencerStuart, 2006.)
LID and Executive Turnover and
Compensation:
• LID can serve as a monitoring mechanism
• to remove poorly performing CEOs.
• to mitigate agency costs associated with dual CEO-board chairman.
• to properly align CEO incentives with shareholders.
• to monitor/remove non-executive chairmen.
Hypothesis overview:
1. Good governance
• LID adoption is an attempt to improve board and firm governance.
2. Window dressing
• LID’s are simply window dressing to minimize investor/ public scrutiny
(neutral position).
• LID designed to protect autocratic CEO from scrutiny but not influence
decision making (negative).
• Our basic research question:
• Which view dominates?
Hypothesis overview:
• Identify determinants for firms appointing an LID.
• LID impact on:
• Corporate performance (H1)
• Profitability.
• market-to-book ratio.
• excess returns.
• CEO succession planning “turnover” (H2)
• CEO turnover/performance sensitivity.
• CEO compensation (H3)
• compensation levels.
• excess compensation.
• wealth sensitivity to stock volatility (Vega) and stock price (Delta).
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Hypothesis Development (H1):
• LID board role may improve quality of information provided to board.
• Creates an environment where independent directors can act with
autonomy.
• Greater levels of monitoring of the CEO.
• H1: Firms with an LID board role have higher profitability and higher market-to-book ratio.
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Hypothesis Development (H2):
• Better governed firms have greater CEO turnover performance sensitivities
• Coughlan and Schmidt (1985), Brickley (2003), Warner, Watts & Wruck (1988), Weisbach (1988),
Murphy (1999).
• Anecdotal evidence
• 71% of respondents to PWC study indicate LID involvement in CEO succession decisions is
“critical.”
• H2: IF an LID board role is an effective monitoring mechanism then, ceteris paribus, we expect
higher CEO turnover/performance sensitivity.
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Hypothesis Development (H3):
• If LID is an effective governance mechanism we would expect
compensation to be lower and more closely aligned with
shareholder interests.
• Jensen and Murphy (1990), Berger, Ofek and Yermack (1997), Core and Guay (2002).
• H3: If LID is an effective monitoring mechanism then we expect CEOs to have
stronger risk taking incentives and lower excess compensation.
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Data Sources / Sample:
• Time period
• 2000-2009 fiscal years.
• Datasets
•
•
•
•
•
BoardEx – identify LID’s from information about individual directors.
ExecuComp – CEO compensation data.
Compustat – firm level data.
CRSP – returns.
Sample size:
• # of unique LIDs: 1,636.
• Total firm year observations: 19,420.
Table 2:
Market Valuation / Performance:
Abnormal Returns:
CEO Turnover:
CEO Incentives:
Excess Compensation:
Duality Interaction:
Large Board Interaction:
Busy Board Interaction:
Conclusions:
• We document an unexplored board governance mechanism, the LID.
• LID’s are associated with higher firm performance.
• LID’s are associated with higher CEO-turnover-performance sensitivities.
• LID’s are associated with stronger risk-taking incentives for the CEO.
Future Work:
• LID and investment policy, in particular, M&A activity.
• LID and risk assessment – reliable accounting reporting.
Thank you.
First Differences Analysis:
Firm Fixed Effects: