The Brain Gain of Corporate Boards: Evidence from China

• Date: 01 August 2015
• DOI: http://doi.org/10.1111/jofi.12198
• Author: MARIASSUNTA GIANNETTI,XIAOYUN YU,GUANMIN LIAO
• Published date: 01 August 2015

THE JOURNAL OF FINANCE •VOL. LXX, NO. 4 •AUGUST 2015

The Brain Gain of Corporate Boards: Evidence

from China

MARIASSUNTA GIANNETTI, GUANMIN LIAO, and XIAOYUN YU∗

ABSTRACT

We study the impact of directors with foreign experience on firm performance in

emerging markets. Using a unique data set from China, we exploit the introduction

of policies to attract talented emigrants and increase the supply of individuals with

foreign experience in different provinces at different times. We document that per-

formance increases after firms hire directors with foreign experience and identify

the channels through which the emigration of talent may lead to a brain gain. Our

findings provide evidence on how directors transmit knowledge about management

practices and corporate governance to firms in emerging markets.

THE BOARD OF DIRECTORS is expected to monitor and provide advice to manage-

ment (Fama and Jensen (1983)). The extent to which boards fulfill these duties

is widely debated and may depend largely on the characteristics and skills

of the directors (Adams, Hermalin, and Weisbach (2010)). Board composition

may be particularly important in emerging markets, where firm performance

∗Mariassunta Giannetti is from the Stockholm School of Economics; the Centre for Economic

and Policy Research; and the European Corporate Governance Institute. Guanmin Liao is from the

Central University of Finance and Economics School of Accountancy, and Xiaoyun Yu is from the

Indiana University Kelley School of Business and the China Academy for Financial Research. We

thank Michael Roberts (the Editor), two anonymous referees, Ken Ahern, Laurent Bach, Walid

Busaba, Chun Chang, Jess Cornaggia, Yaniv Grinstein, Juanna Joensen, Daniel Metzger,

Zacharias Sautner, Wei-Ling Song, Frank Yu, and seminar participants at the Western Finance

Association annual meeting (Las Vegas), the European Finance Association annual meeting

(Copenhagen), the CFEA Conference at the University of Southern California, Marshall School

of Business, the Asian Finance Association annual meeting (Nanchang), the Financial Interme-

diation Research Society Conference (Dubrovnik), EDHEC, ESSEC, Fudan University, Indiana

University, Louisiana State University, the Shanghai Advanced Institute of Finance at Shanghai

Jiao Tong University, the Vienna Graduate School of Finance, the Stockholm School of Economics

(SITE), the University of St. Gallen, the University of Nottingham, and the University of Western

Ontario for helpful comments. M. Giannetti acknowledges financial support from the Jan Wal-

lander and Tom Hedelius Foundation and the Bank of Sweden Tercentenary Foundation. G. Liao

acknowledges financial support from the National Natural Science Foundation of China, Grant

Nos. 70902001 and 71272233. This paper was started when G. Liao was visiting Indiana Uni-

versity, which we thank for the generous hospitality. X. Yu acknowledges financial support from

CIBER at Indiana University; the Arthur M. WeimerFaculty Fellowship; and the National Natural

Science Foundation of China, Grant No. 71202045.

DOI: 10.1111/jofi.12198

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is known to be hampered by weak corporate governance and poor management

practices (Syverson (2011)).

Board members with foreign experience could help to improve firm perfor-

mance in emerging markets through at least three channels. First, having

learned how foreign organizations work, directors with foreign experience may

facilitate the adoption of superior management practices, shown to enhance

firm performance and productivity (Bloom and Van Reenen (2007)). These di-

rectors could thus help to reduce the large productivity gaps that persist across

countries and firms (Hall and Jones (1999), Jones and Romer (2009)). Second,

directors with foreign experience may have connections in foreign countries

that facilitate foreign acquisitions and international capital raising activities.

Finally, directors with foreign experience may be more effective at performing

the monitoring function and improving firm-level corporate governance, not

only thanks to the expertise accumulated abroad, but also because they have

relatively weaker local ties and hence may have stronger incentives to pursue

profitability rather than pleasing politicians and other local constituencies.

However, in environments with weak investor protection, it is also possible

that the board of directors is captured by management and controlling share-

holders, and is therefore ineffective. Thus, whether the board matters and how

it affects corporate policies are particularly relevant for emerging markets.

This paper examines whether attracting exceptionally talented individuals

with foreign experience to the board has positive effects on the performance of

firms in emerging markets. To do so, we use a unique hand-collected data set

from China. China provides a unique environment to address these issues for

several reasons. First, Chinese firms face a severe shortage of managers that

can effectively work in an international environment (see, for instance, Farrell

and Grant (2005)). Since individuals with foreign experience are scarce, not

all firms with similarly high demand for directors with foreign experience are

able to attract one. Second, individuals obtain their foreign experience in a

variety of countries and we are able to hand-collect information on foreign

education, work experience, and other demographic characteristics from the

bios of 32,823 executive and nonexecutive directors of 1,667 publicly listed

companies from 1999 to 2009. This wealth of information allows us to explore

how directors’ foreign experience matters. Third, and most importantly, during

the sample period, almost all provinces introduced incentives for highly skilled

individuals with foreign experience to return and did so at different times. We

document that the labor market for board directors is largely local in China as

in the United States (Knyazeva, Knyazeva, and Masulis (2013)). Therefore, the

introduction of the provincial policies led to an exogenous change in the supply

of potential directors with foreign experience for the firms headquartered in

those provinces.

The timing of the introduction of the incentives was largely independent from

the characteristics and growth opportunities of the publicly listed firms in the

province. We show that, after the policy changes, the number of directors with

foreign experience increases more for the firms headquartered in the provinces

adopting the policies than for comparable firms elsewhere. This is the case not

The Brain Gain of Corporate Boards 1631

only because some individuals return and become executive directors of the

company, but mostly because there is a larger pool of individuals with foreign

experience working in the area who can become independent directors.

By exploiting the change in directors with foreign experience due to the

change in provincial policies, we can estimate the effects of directors with for-

eign experience for firms whose behavior can be manipulated by the policies.1

Our estimates indicate that, when individuals with foreign experience join a

firm’s board, the firm’s valuation improves and its total factor productivity

increases. In the subsequent years, the firm’s profitability increases. We also

show that these improvements in performance are accompanied by changes

in corporate policies that are generally set by the board. First, firms’ propen-

sity to manage earnings decreases, indicating that corporate governance im-

proves. Second, among the firms that make mergers and acquisitions, those

with board members with foreign experience are more likely to make an inter-

national merger or acquisition. This suggests that these firms are able to access

a broader range of investment opportunities. Similarly, firms with board mem-

bers with foreign experience are more likely to engage a foreign investor when

raising capital through private placements than other firms. Finally,firms that

hire directors with foreign experience start exporting more.

Overall, these results suggest that firm performance improves because,

among other effects, directors with foreign experience facilitate the adoption of

strong corporate governance practices and internationalization. These findings

contribute to the growing literature on whether and how boards matter and

provide first-time evidence on the extent to which international competition for

talent affects firm corporate governance and performance.

The benefits produced by directors with foreign experience may arise be-

cause of their exceptional talent or their foreign experience. It is difficult to

distinguish between these two nonmutually exclusive explanations because

exceptional talent is often considered a result of exceptional experience.2Nev-

ertheless, we provide suggestive evidence that the directors’ foreign experience

matters beyond their abilities.3First, we show that firms internationalize their

businesses by expanding sales, raising funds, and acquiring firms in the coun-

tries where the directors obtained their foreign experience. Second, the type

of foreign experience affects corporate policies. When individuals that gained

their foreign experience in countries with strong management practices, such

as Germany or Sweden, join the board, firms experience improvements in op-

erational efficiency. Conversely, directors that gained their foreign experience

in strong corporate governance countries are associated with higher CEO pay-

performance sensitivity, higher sensitivity of turnover to performance, less

1While the estimates are specific to these firms, we believe that this is the population of intrinsic

interest as these are the firms that demand directors with foreign experience.

2See, for instance, the discussion in Colvin (2008) and Gladwell (2008).

3Our results, however, should not be interpreted as indicating that any individual, if they

acquired some foreign experience and joined the board of a listed company, would have an effect

on firm performance similar to the one we find, as the policies were clearly directed to exceptional

individuals.