Independent Board Members Prove Worth in Fast-Paced Industry
Input from independent board members helps companies stay ahead of new entry threats in the fast-paced world of technology, research from the University of Maryland’s Robert H. Smith School of Business shows. The study, co-authored by Maryland Smith professors Peng Huang and Anand Gopal, along with Louisiana State University professor and Maryland Smith PhD alumna Yang Pan, explores the value of having outside perspectives in the IT industry.
Past research has produced mixed evidence on the relationship between the independence of the board of directors — the degree to which the board consists of outside directors not affiliated with the company — and firm performance. But the new study, forthcoming in MIS Quarterly, considers a special dynamic in information technology that does not apply in slow-moving industries with stable market structures.
“The presence of significant new entry threats is a unique feature that differentiates the IT industry from many other industries,” the authors write. “We show that facing high new entry threats, firms with boards with a high proportion of independent directors, who contribute to explorative organizational learning, carry out more effective monitoring and offer independent opinions in strategic decision making, outperform firms with fewer independent board members.”
Outside perspectives are especially important in IT for at least two reasons. First, fast clock-speed puts pressure on firms to adapt continually to changing market conditions, which elevates the advisory role played by the board.
Second, the entrepreneurial environment in IT gives rise to many powerful CEO founders who also serve as board chairs. “Such CEO-chairman duality is often associated with weak boards in general,” the authors write. “The prevalence of these conditions within the IT industry suggests that the firm’s executives can potentially act against the best interests of shareholders.”
This became clear in the early 2000s, when accounting scandals at companies such as Enron and WorldCom put the spotlight on corporate governance and led to the Sarbanes-Oxley Act.
To measure the value of board independence, the authors first develop a text-based instrument to assess new entry threats — something difficult to predict in real time because many startups create noise but flame out before disrupting the market.
The authors also account for hidden or changing variables in board composition by using Sarbanes-Oxley and subsequent regulatory changes as points of reference.
By looking at compliant firms (those with boards that included more than the required ratio of independent directors prior to Sarbanes-Oxley) and noncompliant firms (those with boards that included less than the required ratio of independent directors prior to Sarbanes-Oxley), the authors can compare the differential shocks while filtering out hidden variables. “Such changes are independent of the unobserved firm-specific variables correlated with firm performance,” the authors write.
They then apply their instruments to a sample of public firms in the IT hardware and software industries from 1997 to 2013.
“We consistently find a moderating effect of new entry threats,” the authors conclude. “Facing greater new entry threats, firms with a higher proportion of independent board members systematically outperform those with insider-dominated boards.”
Read more: Board Independence and Firm Performance in the IT Industry: The Moderating Role of New Entry Threats is featured in MIS Quarterly.