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Bottom line gets a boost when leader joins other boards

Monday, May 16, 2011

Being part of another company's board can help improve the profitability of the CEO's home company, new study finds

WALLACE IMMEN

The prejudice against allowing CEOs to serve on outside boards may be doing companies and their leaders a disservice, a new study suggests.

In fact, far from being a distraction from a top executive's duties, serving on another company's board can pay big dividends to the business he or she leads.

That's the conclusion of a sweeping look at 460 chief executive officers at large U.S. companies - including many that have operations in Canada - and their results over the past 10 years.

The findings turn a commonly held belief on its head, said Brian Boyd, a professor of management at Arizona State University, co-author of the study. "It is widely believed that outside service distracts top executives from their primary home-company responsibilities, gives a superfluous boost to already ample egos, and, in sum, constitutes little more than a form of managerial opportunism," he said.

But the study, which looked at a wide range of businesses through two economic downturns, "found no evidence whatsoever that there are any negative effects on any company's profitability from having their CEO sitting on outside boards," he said.

Indeed, the analysis found that low-growth industries, low-concentration industries and relatively undiversified companies whose CEOs had outside directorships actually registered notably better financial performance, in terms of profits and return on investment, than those that did not.

"It seems ironic that in the present period of low growth, many firms are under the impression that having their top executives serve on outside corporate boards is a luxury they can't afford," said Marta Geletkanycz, an associate professor of strategic management at Boston College and co-author of the study, which appears in the current issue of Academy of Management Journal..

"Our findings suggest that it is especially in the context of low growth that CEO service on an outside board is most advantageous to the chief's own firm," she said.

The researchers theorize that CEOs benefit from the contacts with other top executives and directors while sitting on a board; they gain broader insights on how decisions have worked out in other industries and how they may be adapted to solve issues in their home company.

"It's a bit like being on training wheels," said Prof. Boyd. "If you are on the board of a company that is going through a transition, it is an opportunity to try out, and bounce off, ideas on decisions you didn't actually make but are being played out somewhere else."

Two-thirds of S&P firms impose limits on CEOs in terms of the number of boards they can sit on, or the time they can devote to board work; many companies have adopted outright proscriptions. For example, London Stock Exchange guidelines recommend that CEOs should sit on only one or two boards and for only limited periods.

The trend of setting limits on CEO board memberships has accelerated since the 1990s, and the belief that outside service will have an impact on a company's bottom line has become so prevalent that announcement of a CEO joining an outside board often triggers a decline in the home company's stock, Prof. Geletkanycz noted.

This has caused a sharp decline in board activity by active executives. According to the board index of recruiting firm Spencer Stuart, CEOs and other top executives are the most ardently sought individuals for directorships of other companies because of their first-hand knowledge of strategic leadership issues. Yet last year, they represented only 25 per cent of all newly appointed independent corporate directors, compared with about 50 per cent a decade ago.

Prof. Boyd said the study results indicate that senior executives shouldn't be constrained by blanket prohibitions against outside board service. Instead, they should look for a "customized" approach as to which boards they join.

"All of the governance codes and guidelines are very well intentioned," he said, "but we found that they can become strait jackets that don't serve the needs of the company."