Director attention and firm value

• Published date: 01 June 2020
• Author: Rex Wang Renjie,Patrick Verwijmeren
• DOI: http://doi.org/10.1111/fima.12259
• Date: 01 June 2020

DOI: 10.1111/fima.12259

ORIGINAL ARTICLE

Director attention and firm value

Rex Wang Renjie1Patrick Verwijmeren1,2

1ErasmusSchool of Economics, Rotterdam, The

Netherlands

2Department of Finance, University of

Melbourne, Melbourne, Australia

Correspondence

RexWang Renjie, Campus Woudestein,

E-Building,Burgemeester Oudlaan 50, 3062

PARotterdam, Netherlands.

Email:rwang@ese.eur.nl

Abstract

In this article, we show that exogenous director distraction affects

board monitoring intensity and leads to a higher level of inactivity by

management. We construct a firm-level director “distraction”mea-

sure by exploiting shocks to unrelated industries in which directors

have additional directorships. Directors attend significantly fewer

board meetings when they are distracted. Firms with distracted

board members tend to be inactive and experience a significant

decline in firm value. Overall,this article highlights the impact of lim-

ited director attention on the effectiveness of corporate governance

and the importance of directors in keeping management active.

1INTRODUCTION

A board of directors has the critical task of actively monitoring and advising top management to ensure that managers

actin the best interest of shareholders. However, a directorship is rarely a full-time job. Most directors have other occu-

pations besides their directorships, and many directors serve on multiple boards. Given that attention is not unlimited

for directors, we ask whether directors can perform their job effectively when their other occupations require more of

their attention. Consequently,we examine how a firm performs when its directors are distracted.

Understanding the effect of director attention is important to evaluate the role and importance of corporateboards

in corporate governance. In this article, we empirically study the impact of limited director attention on firm value by

exploiting exogenous variation in board monitoring intensity from time variation in how directors allocate attention

across their multiple directorships. We find strong evidence that distracteddirectors spend less time and energy mon-

itoring and advising managers, which gives managers the freedom to shirk at the expense of shareholders, leading to

significant declines in firm value.

We rely on a sample of RiskMetrics firms with at least one outside director with multiple directorships in the

Directors database. These directors need to distribute attention among their directorships, which provides a useful

setting to study the effect of director attention. As we cannot observe exactly how much time or energy direc-

tors spend on each of their directorships, our identification strategy is designed to exploit plausibly exogenous

variation in how directors allocate attention across their directorships. The following simple thought experiment

illustrates our approach. Consider two otherwise identical companies in a given industry and quarter.Director A sits

on the board of Company 1 and on the board of firm “Car” in a totally different industry, namely, the automotive

c

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Financial Management. 2020;49:361–387. wileyonlinelibrary.com/journal/fima 361

362 RENJIE ANDVERWIJMEREN

industry. Director B sits on the board of Company 2 and on another firm that is not in the automotive industry.

Suppose now that there is an attention-grabbing event in the automotive industry. Assuming limited attention,

Director A may shift attention toward firm Car and away from Company 1. The manager at Company 1 conse-

quently receives less monitoring and advice. In contrast, Company 2 is not affected because its director is not

related to the automotive industry. Thus, we can identify the impact of variation in director attention on firm value

by studying the changes in the value of Company 1 relative to that of Company 2 around the time Director A is

distracted. We assign each firm to 1 of the 49 Fama–French industries (provided in Kenneth R. French'sdata library

at: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html)and use unusually high volatility as the

main empirical proxy for attention-grabbing events.This identification approach is similar to that of Kempf, Manconi,

and Spalt (2017), who study how investor attention matters for corporate actions. We confirm that our results are

robust to alternative industry classifications and various definitions of industry shocks.

Toobtain insights into whether our measure of director distraction captures director attention, we start by exam-

ining board meeting attendance. We show that directors identified by our measure as distracted attend fewer board

meetings. We next employ our measure of director distraction to study how director attention affects firm value. By

examining Tobin'sQ and stock performance, we find that firm value drops significantly when board members are dis-

tracted. A deviation from no distractionto the average distraction level is associated with a 3.3% discount in quarterly

Tob in 's Q, and a stock marketunderperformance of about 72 basis points per quarter. This effect is particularly strong

when the distracted directors sit on an important committee of the board.

Because our tests either include industry ×quarter fixed effects or explicitly control for industry-specific shocks,

our results are not likelydriven by spillovers among industries or by any variable that does not vary across firms within

a given industry and quarter, such as the state of the business cycle. Firm-level,time-invariant, unobservable factors

cannotdrive our findings as we also include firm fixed effects. Even with these fixed effects, a remaining concern relates

to the endogeneous nature of director appointments. For instance, Company 1 chooses Director A, who also holds

a directorship in the automotive industry, because the business of Company 1 is related to the automotive industry,

whereas this is not the case for Company 2. Thus, shocks in the automotive industry spill overto Company 1 but not to

Company 2. Toalleviate this concern, we provide three pieces of evidence.

First, we argue that the direction of the spillovereffect is mostly consistent with the direction of the industry shock.

If the automotive industry experiences a positive shock, the effect spilled over to Company 1 is likely also positive

and vice versa for negativeshocks. We therefore examine distraction from positive and negative industry shocks sepa-

rately.We show that director distraction from both positive and negative shocks in the other industry affects firm value

negatively.Second, because shocks in the oil and gas industry can especially have spillover effects (also in the opposite

direction), we modify our distraction measure by removing shocks from oil and gas industries, and we repeat our anal-

ysis on a subsample excluding firms operating in those industries. The results remain similar to the baseline results.

Third, we ensure that attention shocks come from unrelated industries by excludingshocks from supplier or customer

industries, and again we find similar results, which support the validity of our distraction measure in capturing director

attention shocks rather than industry relatedness or comovement.

This article is related to a large literature on the busyness of corporate boards. Some studies find that directors

with multiple directorships are too busy to effectively monitor management (Core, Holthausen, & Larcker, 1999;

Falato, Kadyrzhanova, & Lel,2014; Fich & Shivdasani, 2006), whereas other researchers find that busyness reflects the

quality of directors, which could provide advantages for firms (Ferris, Jagannathan, & Pritchard, 2003; Field, Lowry,

& Mkrtchyan, 2013; Gilson, 1990; Kaplan & Reishus, 1990; Shivdasani & Yermack, 1999). Our study disentangles

busyness from director ability and provides evidence on the costs of havingbusy directors.

A noteworthy feature of our identification strategy is that we consider the source of distraction at the industry

level rather than at the firm level.1Afirm-level approach has the crucial disadvantage that firm-level shocks could be

driven by the ability of the director.For instance, if we classify Director A as distracted when company Car does poorly

(as opposed to the whole automotive industry), this could simply be attributed to the bad performance of Director A.

1Steinand Zhao (2016) examine director distraction when the source of distraction is at the firm level.