Corporate governance and board networks

Description of preliminary research ideas

Business relations among companies with common directors are pervasive. How much do modern corporations rely on director networks? How useful are common directors and other forms of board networks in overcoming information problems? How does the existence of board networks affect the likelihood that two companies do business together, and the magnitude of that business? What is the effect of board networks on profitability? Under what circumstances is reliance on these networks in shareholders' best interests? What was the role of such networks in the 2008-9 financial crisis? Would a policy of prohibiting particular kinds of board networks yield positive net social benefits?

In theory, corporate board networks can serve a useful role in helping companies overcome information barriers. However, reliance on such networks induces additional correlation in company performance and could, from a risk point of view, be a disadvantage. Such networks can also suppress transparency and strong, independent oversight -- two pillars of good governance -- and thereby introduce additional disadvantages. Hence, the desirability of board networks cuts both ways. These are potentially systemic issues that may have played an important role in causing, or alternatively in helping good companies survive, the 2008-9 financial crisis.

Confronting these issues with quantitative analysis presents serious methodological challenges. Among them is an identification problem arising from the fact that companies sharing a board network are more likely to be doing business with each other for reasons other than the presence of a common board network. For example, two companies with a business relationship are more likely to have a common board member because they are more likely to be in the same industry, and directors are often selected on the basis of their expertise in a company's industry. The problem that this particular example presents is mitigated by the fact that pools of potential directors are not necessarily shallow, even within rather narrow industry cells. Furthermore, directors who lack expertise in a company's particular industry are often selected to fulfill oversight and audit functions.

In order to address these issues, one needs time series data on inter-company business relationships and on corporate directors. Directors' selection onto corporate boards should be addressed with an instrumental variables strategy. In order to instrument for directors' selection onto corporate boards, one needs to observe something that affects the probability of selection but that is otherwise uncorrelated with the probability that two companies do business with each other or with the magnitude of the business that they do. The time series dimension of the data can be exploited to add industry or company-pair fixed effects. This would more convincingly establish causation, and would permit cross-industry comparisons of the effects of board networks.