WHOM YOU CONNECT WITH MATTERS: DIRECTOR NETWORKS AND FIRM LOCATION

• Author: Rachel Wilson,Lindsay Baran
• Date: 01 March 2018
• DOI: http://doi.org/10.1111/jfir.12141
• Published date: 01 March 2018

WHOM YOU CONNECT WITH MATTERS: DIRECTOR NETWORKS

AND FIRM LOCATION

Lindsay Baran

Kent State University

Rachel Wilson

Wittenberg University

Abstract

We examine whether board members serve as a channel for remotely located firms to

access the benefits from business-dense areas due to economies of agglomeration. We

find that geographically remote firms benefit from connections to firms in top

metropolitan statistical areas (MSAs) for business density. After controlling for director

compensation, we find connections to top MSA firms mitigate the negative effect of

increased distance from business-dense areas. We address concerns of endogeneity by

exploring a sample of firms whose directors gain board seats at top MSA firms and find a

similar positive impact of connections to top MSA firms.

JEL Classification: G30, G34

I. Introduction

In their seminal work on the resource-dependency theory, Pfeffer and Salancik (1978)

state that board members are one channel for firms to access external resources that

cannot be produced internally. In this spirit, board network analysis explores the way

choosing well-connected directors can have significant economic implications for a firm.

Relatedly, the theory of economies of agglomeration maintains that business-dense areas

are able to attract needed resources and create environments for knowledge spillovers,

which has implications for firm location. Taken together, the question naturally arises as

to whether the value of director connections is enhanced by appointing directors with

connections to business-dense areas. Our study intersects this concept of board networks

with the theory of economies of agglomeration. We are particularly interested in

remotely located firms that lack direct access to these resources and knowledge.

Board network analysis has not carefully considered the geographic location of

board connections.

1

In our article, we focus on one channel that remotely located firms

could use to access the benefits of economies of agglomeration: appointing directors with

This article benefited from the help of an anonymous reviewer as well as the journal editors. We also thankthe

participants at the annual meetings of the Southern Finance Association (2016) and the Financial Management

Association (2017), Babak Mammadov (discussant), and Rachita Gullapalli (discussant).

1

We discuss the studies by Knyazeva, Knyazeva, and Masulis (2013), Engelberg, Gao, and Parsons (2013),

O’Hagan and Green (2002), and Rice et al. (2012) in this area in Section II.

The Journal of Financial Research Vol. XLI, No. 1 Pages 113–147 Spring 2018

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© 2018 The Southern Finance Association and the Southwestern Finance Association

ties to business-dense areas. Compared to firms located within business-dense cities,

remotely located firms face a smaller supply of directors and thus may experience a

different impact from appointing directors with connections to business-dense areas. Our

study investigates whether the benefits of economies of agglomeration can be transmitted

to remotely located firms via board members with ties to business-dense areas. We find

support for this channel that is robust to multiple measurements of board ties with

business-dense areas as well as tests that mitigate concerns of endogeneity.

In our study, we extend the researchon the impact of director connections to firm

value (Barnea and Guedj 2007;Cai and Sevilir 2012; Engelberg, Gao, and Parsons 2012;

Fracassi and Tate2012; Hwang and Kim 2009; Larcker, So, and Wang2013) by exploring

the differential impact based on a firm’s location relative to business-dense areas.

Although director networks have the potential to increase firm value through information

advantages such as best practices, or political favors such as preferential loan rates, such

benefits may not be uniform across varyinggeographical business densities. To segregate

firms by business densities,for each year between 1996 and 2015, we determine thetop 10

metropolitan statistical areas (MSAs) by the number of firms located in the MSA. For all

firms we determinethe minimum distance to a top MSA as well aspartition the sample into

proximal and remote firms, based on the annual median distance to a top MSA.

2

We

compute the percentageof the board with concurrent directorshipson a board in a top MSA

(% Top MSA Directors) as well as the percentageof direct connections to other top MSA

directors (% Top MSA Connections). We test the value of director connections and firm

location simultaneously for firms located outside top MSAs. We show that both % Top

MSA Directors and % Top MSA Connections positively affect firm value, indicatingthat

remotely located firms benefit from appointing directors with access to the resources

available in business-dense areas. The impact of traditional network centrality is negative

(albeit marginally significant) for firms outside top MSAs, suggesting that having well-

connected board memberswith only local experience may be detrimental. Consistentwith

the theory of economies of agglomeration, we also find an inverse relation between

distance to a top MSA and firm value.

Using a hand-collected subsample of director employer location and data from

Alam et al. (2017) on director home addresses, we find consistent results using either

director location based on board appointments compared to home or work address.

Furthermore, we separate the effect of advisory and monitoring directors and find

evidence that the benefits are not limited to one type of director although the impact is

more evident for the advisory role. Our results are also robust to different definitions of

top MSAs.

We then examine our results for three subsamples: by period, by information

problems, and by firm size. Based on data gathered by the United Nations finding that

Internet usage in the United States surpassed 50% by 2002,

3

we partition our sample into

2

The choice to use the top 10 MSAs follows studies such as John, Knyazeva, and Knyazeva (2011) and

Loughran and Schultz (2005) who study the impact of remote firm location on dividend policy and liquidity,

respectively. We further explore the choice of using the top 10 MSAs in Table 6.

3

The time series by country of the percentage of individuals using the Internet can be found at http://www.itu.

int/en/ITU-D/Statistics/Pages/stat/default.aspx.

114 The Journal of Financial Research

1996–2001 and 2002–2015. We find a stronger positive effect of both % Top MSA

Directors and % Top MSA Connections in 1996–2001, before the technological advances

that might reduce the value of proximity. We look at two proxies for information

problems: a scaled measure of intangibles and number of analyst forecasts. Our results

suggest that directors with access to the resources and information in business-dense

areas may confer more value to firms with greater information problems. In addition, we

partition our sample by firm size following Knyazeva, Knyazeva, and Masulis (2013).

For the small and medium-sized firms outside top MSAs, we find greater evidence that

well-connected directors add value; however, we find a negative interaction between %

Top MSA Directors as well as % Top MSA Connections and a remote firm indicator,

suggesting that these connections exacerbate the negative effects of remote location for

small and medium firms. For the largest quartile of firms, however, this interaction is

positive. To attract directors with experience on top MSA boards rather than rely on their

local supply of directors, small and medium firms may have to increase pay. Therefore,

we also control for director compensation and find the sign of the interaction term

becomes positive. After controlling for higher director pay levels, these results indicate

that directors with top MSA experience help to mitigate the negative effects of remote

location.

Finally, we conduct several additional analyses to address the concern that

endogenous decisions of board compensation and firm value drive our findings. We focus

on cases where a director joins a new board of a firm in a top MSA and did not hold any

prior seats on a top MSA board. This creates a shock to % Top MSA Directors that is more

likely to be exogenous. Our tests find a positive value of connections with top MSAs after

these exogenous shocks, supporting our main results. Furthermore, we test whether

reverse causality explains our results and find consistency even using a lag of 10 years

for % Top MSA Directors. Finally, we find our results largely robust to using return on

assets (ROA) instead of Tobin’s Q as our dependent variable.

Our study contributes to the corporate governance field in many ways. First, our

results consider the context of firm location and the role of board connections with a

specific focus on directors with experience in business-dense cities. Our findings support

the resource-dependency theory of interlocking where firms look to external sources for

inputs they cannot produce internally (Pfeffer and Salancik 1978). Firms located outside

top MSAs do not have direct access to the benefits of economies of agglomeration in the

business-dense areas. Thus, these firms may appoint directors with experience or

connections to access these benefits. Specifically, the results suggest that appointing

directors with experience on or connections to top MSAs is beneficial to remotely located

firms. The practical implications of our results suggest that remote firms should seek out

board members with experience and networks in top MSAs to capture some of the

benefits of economies of agglomeration even if they are located remotely.

We also contribute to the research of Alam et al. (2014, 2017) on the location of

directors relative to the firm by considering the location of the firm proximity to business-

dense areas. Alam et al. (2014) show that director distance influences the cost of

information gathering. Alam et al. (2017) find that the Sarbanes–Oxley Act (SOX) leads

to boards with monitoring directors who are located farther away and those with the

largest impact in director proximity experienced lower earnings quality. These studies

Director Networks and Firm Location 115