Is Director Industry Experience Valuable?

• Author: David Oesch,Markus Schmid,Felix Meyerinck
• Date: 01 March 2016
• DOI: http://doi.org/10.1111/fima.12089
• Published date: 01 March 2016

Is Director Industry Experience

Valuable?

Felix von Meyerinck, David Oesch, and Markus Schmid∗

Weinvestigate whether investor reactions to the announcement of a new outside director appoint-

ment significantly depend upon the director’s experience in the appointing firm’s industry. Our

sample includes 688 outside director appointments to boards of S&P 500 companies from 2005

to 2010. We find significantly higher announcement returns upon appointments of experienced

versus inexperienced directors. To alleviate endogeneity concerns, we use the deaths of 200 di-

rectors holding 280 outside directorshipsas an identif ication strategyand f ind significantly more

negative announcement returns associated with the deaths of experienced versus inexperienced

directors. However,while our results are robust to accounting for time-fixed unobservable director

and firm characteristics, we still cannot completely rule out endogenous firm-director matching

driving our results.

Weinvestigate whether the industry experience of outside directors on corporate boards affects

firm value. Investor interest in industry experience at the board level seems to have increased

substantially in the last few years. In particular, in the aftermath of the financial crisis of 2007–

2008, the press, shareholder activists, and corporate governance experts at large have expressed

increasing concern regarding the lack of sufficient industry experience on corporate boards.1

In a recent survey of board practices (Deloitte LLP and Society of Corporate Secretaries &

Governance Professionals, 2012), 47% of directors indicate that industry experience is the skill

most likely to contribute to the success of the board. Widespreadbelief that director qualif ications

and experience matter is also reflected in the new amendments to the Securities and Exchange

Commission’s disclosure rules introduced in December 2009.2

The authors thank TimAdam, Yakov Amihud, Manuel Ammann, Marc Arnold, Emanuele Bajo,Tobias Berg, MarcoBigelli,

Martin Brown,Ettore Croci, FabrizioFerri, Patrick Goettner,Stefan Hirth, Claudio Loderer,Ernst Maug, Daniel Metzger,

Alexandra Niessen-Ruenzi, RaghavendraRau (Editor), Tony Saunders, Friederike Schmid, Alex Stomper,Daniel Streitz,

Urs Waelchli,Alexander Wagner, David Yermack,an anonymous referee, and seminar and conference participants at the

University of Bern, University of Bologna, University of Hamburg,University of St. Gallen, Humboldt University Berlin,

University of Mannheim, 2013 WHU Campus for Finance Conference,and the 2013 Swiss Finance Association Annual

Meetings in Zurich for helpful comments and suggestions. Partof this research was completed while von Meyerinck was

a PhD candidate at the School of Business of the University of Hamburg and while von Meyerinck, Oesch, and Schmid

were visiting scholars at the Stern School of Business, New York University. Von Meyerinck acknowledges financial

support from the German Academic Exchange Service and the School of Business of the University of Hamburg.Oesch

acknowledges financial support from the Janggen-P¨

ohn Foundation.

∗Felix von Meyerinck is an Assistant Professor of Finance at the Swiss Institute of Banking and Finance, University of

St. Gallen in St. Gallen, Switzerland. David Oesch is an Associate Professorof Financial Accounting in the Department

of Business Administration, University of Zurich in Zurich, Switzerland.Markus Schmid is a Professor of Finance at the

Swiss Institute of Banking and Finance, University of St. Gallen in St. Gallen, Switzerland.

1Pozen (2010) argues that in addition to being too large to operate effectively and not devoting sufficient time to board

tasks, today’s boards frequently lack sufficient expertise in the relevant industry. Similarly, when assessing the most

important skills that companies are likely to look for in directors over the next fewyears, Ber tsch (2011)argues that the

focus has shifted from director independence toward directors with industry experience.

2On December 16, 2009, the Securities and Exchange Commission adopted amendments to its disclosure rules

and forms to enhance the information provided to shareholders. These amendments are intended to improve

Financial Management •Spring 2016 •pages 207 – 237

208 Financial Management rSpring 2016

Industry expert directors are expected to possess superior knowledge of products, markets,

competitors, industry-specific regulations, and standards. Thus, industry experience is expected

to affect a director’s monitoring capability, as well as the quality of advice provided to senior

management (Cust´

odio and Metzger, 2013). In this advisory function, boards set the strategic

and operational direction of the company (Armstrong, Guay, and Weber, 2010; Brickley and

Zimmermann, 2010). In fact, surveys conducted among directors suggest that directors consider

the advisory role and their legal duty to review the corporation’s major plans and actions to be

of greater importance than the monitoring role (Demb and Neubauer, 1992; Corporate Board

Member and PricewaterhouseCoopers LLP, 2008).3

Despite the attention director industry experience has received recently, the academic research

regarding the value of director industry experience is still scarce. We add to the literature by

determining whether board industry experience is perceived as value-relevant by stock market

participants. To this end, we investigate whether stockholder reactions to the announcement of

a new director appointment significantly depend on the director’s experience in the appointing

firm’s industry. Using a sample of 688 outside directors appointed to the boards of S&P 500

companies from 2005 to 2010, we find that companies that announce the appointment of an

industry expert director earn significantly higher announcement returns than companies that

announce the appointment of a new director without industry experience (on average about 0.4%

to 0.7% larger).4This finding is not only statistically,but also economically signif icant relativeto

the whole sample of 688 new outside director appointments (where the overall average two-day

announcement return is approximately 0.08%).

To mitigate concerns that our results are driven by other director or firm-specif ic variables

and in line with previous research, we control for various other director characteristics including

gender, age, independence (versus gray outside directors), and whether the director is the chief

executive officer (CEO) of another company. We also control for various firm-level variables

including size, profitability, growth potential, and the firms’ corporate governance structure

as measured by board size, board independence, anti-takeover protection, ownership structure,

whether the CEO is also Chairman of the board, and whether the CEO sits on the nominating

committee, among others.

Our results stay robust to a number of additional tests, for example when applying alternative

industry definitions, when measuring industry experience at the segment level, when controlling

for generalist skills proxied by education and Ivy League university attendance, when omitting

appointments to the boards of financial f irms, or when accounting for omitted, but time-fixed

variations at the firm level using firm f ixed-effects.

A potential concern with our sample is related to US Federal Law (the Clayton Antitrust Act

of 1914), which has forbidden individuals from serving as directors of competing companies.

Even though the intent of the law was to prevent cartels from developing, rather than preventing

conflicts of interest, it has a potential effect on the hiring of outside directors with industry

disclosure regarding risk, corporate governance, director qualifications, and compensation. For more details see

http://www.sec.gov/rules/final/2009/33-9089-secg.htm.

3In this paper, we investigate the valuationeffect of director industry experience. We leave the question as to whether

any valuation effect is derivedprimarily from superior monitoring or from better advice provided to top management to

future research. Such an analysis requires a panel data structure imposing additional endogeneity concerns that are even

harder to address than in our analysis of well-defined director appointment and exit (through death) events.

4Wefocus on the short-term announcement effects as director industry experience, and board composition more generally,

are unlikely to remain constant overtime. Thus, analyzing the long-term performance changes around the appointment of

outside directors with industry experience is a difficult task. Moreover, in an efficient market, short-term announcement

returns incorporate the market’sestimated long-ter m impact of adding a newdirector.