Zombie Board: Board Tenure and Firm Performance

• Date: 01 September 2018
• Published date: 01 September 2018
• DOI: http://doi.org/10.1111/1475-679X.12209
• Author: GILLES HILARY,STERLING HUANG

DOI: 10.1111/1475-679X.12209

Journal of Accounting Research

Vol. 56 No. 4 September 2018

Printed in U.S.A.

Zombie Board: Board Tenure

and Firm Performance

STERLING HUANG

∗AND GILLES HILARY

†

Received 6 August 2014; accepted 12 February 2018

ABSTRACT

We show that board tenure exhibits an inverted U-shaped relation with

firm value and accounting performance. The quality of corporate decisions,

such as M&A, financial reporting quality, and CEO compensation, also has

a quadratic relation with board tenure. Our results are consistent with the

interpretation that directors’ on-the-job learning improves firm value up

to a threshold, at which point entrenchment dominates and firm perfor-

mance suffers. To address endogeneity concerns, we use a sample of firms

in which an outside director suffered a sudden death, and find that sudden

deaths that move board tenure away from (toward) the empirically observed

optimum level in the cross-section are associated with negative (positive)

announcement returns. The quality of corporate decisions also follows an

∗Singapore Management University; †Georgetown University.

Accepted by Christian Leuz. We thank an anonymous referee and our editor for their

insightful and constructive comments that helped significantly improve this paper. Spe-

cial thanks go to Hannes Wagner for generously sharing his data on director deaths. We

wish to acknowledge the helpful input of Renee Adams, Morten Bennedsen, Daniel Bens,

Lily Brooks, Robert Bushman, Guoli Chen, Lily Fang, Denis Gromb, Maria Guadalupe,

Melissa Lewis, Angie Low, Brian Miller, Amine Ouazad, Urs Peyer, Anil Shivdasani, and

workshop and conference participants at INSEAD, Singapore Management University, the

4th INSEAD-London Conference, the 25th Australasian Banking and Finance Conference,

the 2013 Financial Accounting and Reporting Section Mid-year Conference, the 2013 Eu-

ropean Accounting Association Annual conference, the 2013 European Financial Manage-

ment Association Annual meeting, the 2013 American Accounting Association Annual Meet-

ing, and the 2013 Financial Management Association Annual Meeting. Huang gratefully

acknowledges funding from the School of Accountancy Research Center (SOAR) at Sin-

gapore Management University. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

1285

CUniversity of Chicago on behalf of the Accounting Research Center,2018

1286 S.HUANG AND G.HILARY

inverted U-shaped pattern in a sample of firms affected by the death of a

director.

JEL codes: G30; G32; G34; G38; J33; J44; M41

Keywords: board tenure; firm value; corporate policies; learning; entrench-

ment

1. Introduction

The issue of director tenure has gained considerable attention both in the

United States and abroad. On the one hand, some governance experts and

market participants express concerns about long-tenured directors. They

argue that boards with many long-serving directors are entrenched and

indifferent to shareholder concerns (e.g., ISS 2013–2014 Policy Survey).

Extended board service can create a culture of undue deference to man-

agement. On the other hand, inexperienced directors may also be inef-

fective in their role. A short-tenured board may face less significant gover-

nance problems than a long-tenured board, but may have a less complete

understanding of the firm’s business and history, which may diminish the

effectiveness of its monitoring and advising (Pozen and Hamacher [2015]).

Thus, the optimal tenure for directors remains an unresolved issue among

practitioners.

Despite its practical importance, the academic literature on board ef-

fectiveness provides little insight into how the tenure of board members

affects the board’s monitoring and advising abilities. Instead, it mainly fo-

cuses on compositional differences across boards (e.g., Yermack [1996],

Chhaochharia and Grinstein [2007]). In contrast, we examine how board

tenure reflects the tradeoff between a board’s independence and knowl-

edge accumulation. More specifically, we examine how board tenure re-

lates to firm performance and corporate decisions. We operationalize

this tenure by considering the average number of years on the board

of different outside directors. This approach allows us to examine how

the knowledge-independence tradeoff is integrated in group decision. As

noted in the literature (e.g., Szulanski and Jensen [2006], van Knippen-

berg and Schippers [2007]), the consequences of aggregation at the board

level of these individual tradeoffs through group dynamics are not fully un-

derstood at this point.

Our analysis consists of two main parts. First, we examine the relation

between board tenure and firm value. We find evidence of an inverted U-

shaped relation between board tenure and firm value. Firm value reaches

a maximum when the average tenure of outside directors is approximately

10 years. This finding is robust to the inclusion of controls for an array of

38 corporate governance, CEO, and firm characteristics previously shown

as correlated with firm value, and to the inclusion of firm and year fixed

effects. The economic magnitude is such that an increase in board tenure

from five to seven years is associated with an increase in firm value of 2.7%

ZOMBIE BOARD 1287

of the in-sample standard deviation of firm value, while a decrease in board

tenure from 13 to 11 years is associated with an increase of 1.3% of this stan-

dard deviation. We find these estimates both plausible and economically

significant, particularly when compared with the effects of other variables

(capital expenditures, for example). We reach a similar conclusion when

we use the ROA to measure a firm’s performance. The economic magni-

tude is such that an increase in board tenure from five to seven years is

associated with an increase in ROA of 4.3% of the variable standard devi-

ation, while a decrease in board tenure from 13 to 11 years is associated

with an increase of 1.2% of the standard deviation. To mitigate the concern

that our results may simply reflect the effect of tenure diversity on firm per-

formance, we control for the dispersion in individual director tenures in

our specifications. Our results remain unaffected when we consider other

measures of tenure diversity, such as the range and the Herfindahl Index

of board tenure, instead of the dispersion, and other aspects of board di-

versity, such as ethnic, gender, and age diversity. In addition, we find that

the tenure-performance relation is conditional on CEO power and on in-

formation complexity. Specifically, long tenure has a more severe negative

effect on the board when the CEO is more entrenched, for example, when

she has a long tenure as CEO, or is the board chairperson or founder of

the firm. Conversely, the negative effect of a short tenure is exacerbated

when the information environment is more complex. For example, with

low analyst coverage, analyst forecasts are more disperse and less accurate.

Second, we examine the relation between board tenure and various cor-

porate decisions to explain the inverted U-shaped relation between board

tenure and firm value. We find that the accumulation of firm-specific knowl-

edge is associated with improvements in the quality of acquisition decisions,

corporate disclosure, and CEO compensation practices. However, these re-

sults hold only up to a certain threshold. As tenure advances beyond this

point, additional years are associated with a decline in board oversight qual-

ity and an increase in value-destroying activities. These findings suggest that

for each additional year of tenure, the benefits of learning dominate for

“younger” boards, whereas the costs of entrenchment dominate for “older”

boards. This phenomenon is reminiscent of the effect of audit tenure. Us-

ing a quadratic form similar to ours, prior studies (e.g., Chi and Huang

[2005], Davis, Soo, and Trompeter [2009], Bell, Causholli, and Knechel

[2015]) find that auditor tenure is associated with an increase in audit

quality in the initial years, but only up to a turning point, after which it

decreases.1

Although we control for many potentially confounding effects, endo-

geneity problems may still obfuscate the interpretation of these results.

First, causality may operate in the reverse direction: poorly performing

1However, older studies find either consistent negative (e.g., Mansi, Maxwell, and Miller

[2004], Carey and Simnett [2006]) or positive (e.g., Myers, Myers, and Omer [2003], Ghosh

and Moon [2005]) effects.