Asia-Pacific Journal of Financial Studies (2009) v38 n1 pp35-66 CEO Power and Firm Performance: A Test of the Life-Cycle Theory * Maretno A. Harjoto Pepperdine University, Malibu, USA Hoje Jo Santa Clara University, Santa Clara, USA This is one of the seven accepted papers among 76 papers that were submitted to the solicitation by Asia-Pacific Journal of Financial Studies in the special Call-for-Papers event in 2008. Abstract We examine the effects of corporate governance and monitoring mechanisms on the choice of board leadership structure and the value and performance of a firm according to the firm s life-cycle changes. Employing a large and extensive sample during the 1995-2005 period, we find that the board leadership choice is associated with governance characteristics including board independence, managerial entrenchment, and CEO abilities measured by CEO age and CEO tenure after controlling for various firm characteristics. In addition, after correcting for the endogenous treatment effect, our results show that while CEO dualities--i.e., CEO-chair of the board or CEO-nomination committee member- - or CEO pluralities--i.e., CEO-chair of the board, and a chair or a member of the nomination committee--positively influences firm value and performance in firm s early stage, CEO duality or CEO pluralities adversely influences firm value and operating performance in firm s late stage. These results are supportive of the life-cycle theory, suggesting that CEO power concentration is beneficial in firms early stage, but harmful in firm s late stage at which firms require check-and-balance as opposed to dictatorship. In addition, the impact of external monitoring by institutional ownership on firm value and performance is more effective than those of independent board and blockholders ownership while the impact of Sarbane-Oxley Act on firm performance is not significant. Keywords: Life-Cycle Theory; Board Leadership; CEO Plurality; Corporate Governance; Firm Value and Performance * We thank an anonymous referee, Ha Sung Jang, Young Ho Oh, and Carrie Pan for helpful comments and Korea Security Association, the Korea Corporate Governance Service, and the Breetwor Fellowship for financial support. Harjoto is at Graziadio School of Business and Management, Pepperdine University. This paper has been conducted while Jo was visiting the Monterey Institute of International Studies. ** Corresponding Author. Department of Finance Leavey School of Business Santa Clara University, 500 El Camino Real, Santa Clara, CA 95053-0388; E-mail: hjo@scu.edu; Tel: 408-554-4779; Fax: 408-554-5206. 35
CEO Power and Firm Performance 1. Introduction The roles of the CEO, the chairman of the board (COB), and the board nominating committee are all crucial but different. The CEO is responsible for leading the firm s management, whereas the COB is responsible for leading the board. The nominating committee is responsible for nominating individuals to serve on the board. This separation of the board from the nominating process is mainly intended to reduce the possible incidence of self nomination or preferential nomination of other board members, including the CEO from such nominations. The benefit of this separation is to increase the probability of selecting individuals who are more likely to act for the best interest of shareholders. However, sometimes, one individual often holds two (CEO and COB or CEO and chair/member of nominating committee known as a CEO duality) or multiple positions (CEO, COB and chair/member of nominating committee, hereafter is called a CEO plurality). Agency theory (Jensen and Meckling, 1976) suggests that CEO duality or plurality is not ideal for firm value and performance because it could compromise the board s necessary monitoring role of the CEO. Stewardship theory (Donaldson, 1990; Muth and Donaldson, 1998), in contrast, asserts that CEO duality or plurality may be ideal for firm value and performance because of the unity of leadership and control it presents. While those two views are predicting contradictory impact of CEO power concentration on firm performance, there has been no effort reconciling two theories in the literature. In this paper, we apply the life-cycle theory of Fama and French (2001) and DeAngelo, DeAngelo, and Stulz (2006) to reconcile agency theory and stewardship theory of board leadership by assessing whether the probability a CEO concentrating his power by combining the chair of the board and/or the chair or a member of the nomination committee affects firm performance in heterogeneous fashions depending upon the life-cycle of firm stage. Specifically, we examine whether CEO power concentration is beneficial to determine the future direction for growth when the firm is in early stage, while CEO power concentration is detrimental when the firm is in the mature stage at which it requires check-and-balance rather than power concentration. We use retained earnings (RE) divided by total assets (TA) or total equity (TE), following DeAngelo, DeAngelo, and Stulz (2006), as a proxy for the life-cycle stage because firms with low RE/TA tend to be in the capital infusion stage, whereas firms with 36
Asia-Pacific Journal of Financial Studies (2009) v38 n1 high RE/TA tend to be more mature with plenty of cumulative profits. In addition, we explore how differential CEO leadership structure and various monitoring mechanisms affect firm value and operating performance after correcting for endogeneity. In particular, we examine the CEO influence by classifying CEO only, CEO duality (CEO and COB combined position is called CEOCHAIR), another CEO duality of combined CEO and a chair or a member of nominating committee (CEONOM), and CEO plurality of combined CEO, COB, and CEO as a chair/member of nominating committee (hereafter, CHAIRNOM). Well-designed corporate governance systems would align managers incentives with those of shareholders. Hence, firms with more effective corporate governance should place a greater emphasis on value maximization. Thus, we examine two categories of governance devices: internal (ownership concentration and board structure) and external (institutional ownership). Given that there is no clear evidence on the relation among board leadership structure, corporate governance, and firm value, this study explores the impact of various governance mechanisms on firms choice of board leadership structure and its effects on firm value and operating performance after controlling for endogeneity and incorporating firm s life-cycle stages. Most previous studies, however, neither consider the differential impact of CEO power concentration on firm performance in relation to the life-cycle of firm stage, nor handle the endogeneity issue. 1) Without using apposite conditioning variables, or accounting for endogenous treatment effects, in which firms choose better governance quality to begin with, the contribution of various board leadership structures to firm performance will be overstated or attributed incorrectly (Greene, 1993). To properly address those issues, we proceed in two stages. We examine the factors determining board leadership structure extensively in the first stage, and then compare firm performance under various board leadership structures in the second stage. Based upon the large sample of 14,759 firm-year observations during the 1995-2005 period, we initially perform a first-stage probit regression analysis of board leadership structure. The results show that the likelihood of opting for concentrated power is significantly and positively related to governance characteristics such as governance index or entrenchment index, CEO age, CEO tenure, board independence, and director owner- 1) See, for example, Rechner and Dalton (1991), Baliga, Moyer, and Rao (1996), Brickley, Coles, and Jarrell (1997), Goyal and Park (2002), Faleye (2007), and Bhagat and Bolton (2008). 37
CEO Power and Firm Performance ship, as well as firm characteristics such as firm size, leverage, book-to-market ratio, and whether a firm is family owned. In the second-stage analysis, we find that after correcting the endogenous treatment effect and selection bias, respectively, firm value (operating performance), measured by industry-adjusted Tobin s q (ROA along with operating income divided by total assets), are insignificantly (inversely) related to the CEONOM and CEO- CHAIR, and negatively associated with CEO plurality. The results suggest that while some concentration of CEO power could weakly affect firm value and performance, too much concentration of CEO power is more negatively affecting value and performance. More importantly, as we anticipated, we find that the impact of CEO power concentration on firm performance is positive in early stage supporting the stewardship theory, whereas the influence becomes more negative as firm s life-cycle matures, supporting the agency theory. The results remain robust under various specifications including the OLS, the Heckman two-stage regressions, and the instrumental variables approach. Therefore, our results are supportive of the life-cycle theory in board leadership structure compromising the agency theory in the later stage and the stewardship theory in the early stage. This paper contributes to the literature on corporate leadership and corporate governance in three distinct ways. First, we conduct a full examination of the determinants of board leadership structure and provide insights into why firms opt for certain board leadership structure by using all firms available from the Investor Responsibility Research Center s (IRRC) governance and director database during the 1995-2005 period. Second, we apply the life-cycle theory of dividend to the board leadership literature and control the endogenous treatment effects. By appropriately controlling for the endogenous treatment effects, we are able to determine differential impact of CEO duality or plurality on firm value and operating performance as firm s life-cycle advances. Third, we anticipate that the role of corporate governance in the choice of board leadership structure and the impact of that choice on firm value might be different for each of the internal and external governance mechanisms. We believe that this is the first study to examine the role of firm s life-cycle stage and various governance mechanisms across the different aspects of the board leadership choice and value/performance-impact of board leadership structure. We provide further evidence that the impact of institutional ownership on firm value and performance is the most significant and positive among several considered governance and monitoring mechanisms. 38
Asia-Pacific Journal of Financial Studies (2009) v38 n1 2. Data and Measurement 2.1 Data We use an extensive and combined data set from the IRRC s governance and director database, and CDA/Spectrum 13(f) filings during the period from 1995 to 2005. We use the combined database to obtain corporate governance and monitoring characteristics that include the proportion of outside independent directors, the proportion of institutional holdings, the proportion of blockholdings, and entrenchment index. Specifically, (i) our sample firm must be available from the IRRC director database; (ii) insider blockholder data must be available; and (iii) the data for outside institutional holdings must be available from CDA/Spectrum 13(f) filings. These filings contain quarterly information on common-stock positions greater than 10,000 shares or $200,000 for each institution with more than $100 million in securities under management. We also require that sufficient COMPUSTAT and Center for Research in Security Prices (CRSP) data are available for our tests. This sample procedure produces a combined sample of 14,759 firm-year observations of 2,681 firms from 1995 to 2005. Actual samples used in the analyses are slightly different because the data availability is different for each regression analysis. The IRRC does not publish volumes every year, but publishes volumes in the years of 1995, 1998, 2000, 2002, and 2004. Following Bebchuk and Cohen (2005) and Gompers, Ishii, and Metrick (hereafter, GIM) (2003, 2006), we fill in the missing years by assuming that the governance provisions reported in any given year were also in place in the year preceding the volume s publication. For instance, in the case of 1999, for which there is no IRRC volume in the subsequent year, we assume that the governance provisions are the same as those reported in the IRRC volume published in 1998. To conduct the robustness test, we also examine firms from only the IRRC s published years of 1995, 1998, 2000, 2002, and 2004. We also use a different method based on the arithmetic average of 1998 and 2000 to assume the case of 1999. Both approaches do not change the results. 39
CEO Power and Firm Performance 2.2 Measurement of Variables In our tests, following DeAngelo, DeAngelo, and Stulz (2006), we use retained earnings (RE) divided by total assets (TA) or total equity (TE) as proxies for the life-cycle stage. We also use firm ages as additional proxy for firm s life-cycle stage. All financial variables are taken from COMPUSTAT. Additionally, we use four variables measuring the quality of corporate governance systems-managerial equity ownership, board independence, block ownership, and outside institutional ownership,-and collect the other governance data from the IRRC. We measure board independence by the proportion of outside independent directors (INDEPEN). We measure board leadership by a dummy variable of one if the CEO is the chair of the board (CEOCHAIR), another dummy variable if the CEO is the chair or a member of the nomination committee (CEONOM), and the other dummy variable of CEO plurality if the CEO is the chair or a member of the nomination committee and the chair of the board (CHAIRNOM). 2) We measure external monitoring by the equity ownership of outside institutional holders, which we identify as the sum of the greater-than-five percent owners that are unaffiliated with the firm (PCTINSTI). Our proxy for managerial entrenchment is the governance index (GINDEX) developed by GIM (2003). As the basic ingredients for the GINDEX are anti-takeover provisions (ATPs) and the IRRC reports 24 ATPs at the firm level, the GINDEX ranges from 0 to 24. A high value indicates stronger managerial power, and therefore a greater potential for managerial entrenchment. Based on the GINDEX, Bebchuk, Cohen, and Ferrell (2004) examine which provisions, among a set of 24 governance provisions followed by the IRRC, are highly correlated with firm value and stockholder returns. They then create an entrenchment index (EINDEX) based on six provisions--four constitutional provisions that prevent a majority of shareholders from having their way (e.g., staggered boards, limits to shareholder bylaw amendments, supermajority requirements for mergers, and supermajority requirements for charter amendments), and two takeover-readiness provisions that boards establish to be ready for a hostile takeover (i.e., poison pills and golden parachutes). Bebchuk et al. (2004) argue that these six ATPs are the most re- 2) The IRRC data does not distinguish whether CEO is the chair of nominating committee or just a member of nominating committee. CEOCHAIR AND CEONOM are two measures of CEO duality. CHAIRNOM is a measure of CEO plurality. 40
Asia-Pacific Journal of Financial Studies (2009) v38 n1 sponsible for managerial entrenchment and show that the EINDEX drives the main results of firm valuation. This EINDEX ranges from 0 to 6, with a higher value indicating stronger managerial entrenchment. Thus, we also use Bebchuk et al. (2004) EINDEX to measure managerial entrenchment. See the definitions of governance, monitoring, and other control variables in Table 1. Table 1. Variable Name and Definition Variable Definition Return on asset (ROA) Income before extraordinary items to total asset (Compustat) Operating Profit (OPPROFIT) Operating income before depreciation to total asset [Faleye (2007)] TOBINQ Tobin s Q [Chung and Jo (1996)] Industry adjusted Tobin Q (AD- JTOBINQ) Industry Adjusted Tobin s Q [Campbell (1996)] CEO as a chairman of the board (0,1) (CEOCHAIR) Dummy variable equals to 1 if a CEO is a chairman of the board CEO as a nomination committee (0,1) (CEONOM) Dummy variable equals to 1 if a CEO is a chair or a member of the board nominating committee Ordered variable equals 0 if CEO only, 1 if CEO power (0, 1, 2, 3)(CHAIRNOM) CEONOM = 1, 2 if CEOCHAIR = 1, 3 if CEOCHAIR = 1 and CEONOM = 1 GIM Index (GINDEX) Gomper, Ishii, and Metrick Index [Gompers, Ishii, and Metrick (2003)] BCF Entrenchment Index (EINDEX) Bebchuk Entrenchment Index [Bebchuk, Cohen, Ferrell (2004)] CEO age (CEOAGE) Age of CEO CEO tenure (CEOTENURE) CEO tenure Pct. CEO ownership (PCTCEOSHR) Percentage of CEO share ownership (%) Pct. boards ownership (PCTDIRSH) Percentage of all boards ownership (%) Log of board size (LOGDIRSIZE) Proportion of independent board (INDEPEN) Log of block ownership (LOGBLKS) Pct. Institutional shareholding (PCTINSTI) Log of market value of equity (LOGMVE) Retained Earnings (EARNINGS) Total debt to asset (LEVERAGE) Log of total number of board seats Total number of independent boards divided by total number of board seats Log of sum of blockholders (non institutional holders with 5% or more) Percentage of institutional investors ownership (%) Log market value of equity (inflation adjusted) Cumulative retained earnings ($ million) Total debt to total asset 41
CEO Power and Firm Performance Total R&D expense to asset (RNDR) Log of market to book ratio (MKTBOOK) Deviation of stock returns (DEVRET) Diversification (SEGDIV) Family firm (0, 1) (FAMFIRM) Firm age (FIRMAGE) S&P 500 firms (0, 1) (SP500) Capital expense to asset (CAPEX) Advertising expense to asset (ADVR) Total R&D expense to total asset Log[(Market Value of Equity + Preferred Stock + Book Value of Debt)/Total Asset] Standard deviation of monthly stock returns 5 years prior to current year (%) Number of firm s business segments indicated by 4 digits of SIC codes Dummy variable equals to 1 if the firm is family owned Firm age is calculated from the beginning of the year from the CRSP database Dummy variable equals to 1 if the firm is listed in the S&P500 Index Total capital expenditure to total asset Total advertising expense to asset Sales growth (SALEG) One year sales growth (%) Dividend to book value of equity (DIVR) Total dividend to book value of equity We measure firm value with Tobin s q (1958). In addition, we also use industryadjusted Tobin s q (the natural log of firm s q divided by the median q in the firm s industry) as additional measure of firm value (Campbell, 1996). The advantage of using industry-adjusted Tobin s q (ADJTOBINQ) is that it neutralizes the effect of specific industries on Tobin s q. We measure operating performance by ROA and operating profit (OPPROFIT) using operating income before depreciation to total asset, following Faleye (2007). 3. Literature and Hypothesis 3.1 Literature Review Previous studies suggest that the literature on board leadership largely focuses on CEO/Chairman of the Board (COB) duality. To date, the empirical evidence on the CEO duality is mixed. Rechner and Dalton (1991), Goyal and Park (2002), and Bhagat and Bolton (2007) provide evidence supporting the idea separating chairman and CEO duties. Baliga, Moyer, and Rao (1996) and Brickley, Coles, and Jarrell (1997) suggest that CEO duality is not related to inferior performance. While the empirical evidence on CEO/COB duality is largely inconclusive, evidence on the impact of 42
Asia-Pacific Journal of Financial Studies (2009) v38 n1 CEO/nomination committee duality or CEO plurality on firm value and performance is relatively limited. Fich and White (2005) argue that when the CEO is on the nominating committee, she is influential in the selection of board members, and therefore those board members are more likely to be loyal to the CEO than to the shareholders. Indeed, Shivdasani and Yermack (1999) show that market reactions are significantly lower when the CEO is on the nominating committee than when the CEO is not. Grinstein and Hribar (2004) suggest that CEOs with greater board influence through CEO duality or CEOs on the nomination committee earn greater bonuses. Brickley, Coles, and Jarrell (1997) maintain that the CEOs are awarded the COB title as a part of the promotion and succession process. Brickley, Coles, and Linck (1999) suggest that successful CEOs are more likely to remain on the board as the COB after they retire. Faleye (2007) claims that firms consider the benefits and costs of alternative leadership structures and that pushing all firms to separate CEO and COB duties may be counterproductive. Linck, Netter, and Yang (2008) suggest that the CEO and COB posts are combined in large firms and when the CEO is older and has a longer tenure. 3.2 Hypotheses Formation We first focus on the impact of managerial entrenchment on CEO power concentration. We can interpret GINDEX in two different ways. First, the IRRC reports 24 ATPs at the firm level, so the GINDEX ranges from 0 to 24, with a higher index indicating stronger managerial power and therefore a greater potential for managerial entrenchment. If this interpretation is true, the greater entrenchment should deter pressure from the market for control, resulting in more power concentration. In this case, power concentration and the GINDEX would be positively related. However, the index can also be thought of as reflecting the pressure coming from the market for control, i.e., takeover pressure as external monitoring mechanism, in the form of potential takeover threats. The stronger takeover pressure would make managers be more careful not to deviate from shareholders best interests. If the latter were true, the pressure from the market for control as external monitoring mechanism should result in less power concentration, so power concentration and the GINDEX should be negatively related. Hence, we expect that: 43
CEO Power and Firm Performance Entrenchment vs. External Monitoring Prediction 1: If managerial entrenchment (takeover pressures as external monitoring) dominates external monitoring (managerial entrenchment), then the choice of power concentration measured by the board leadership, i.e., CEO Duality or CEO Plurality, is positively (inversely) associated with managerial entrenchment after controlling for confounding factors. The impact of board leadership on firm value and performance in different lifecycle stages is not scrutinized in the literature. Thus, after controlling for the endogeneity issue, we address the relation between CEO power concentration and firm value/performance as firm s life-cycle advances. The prediction for early-stage firms is that the impact of concentrated CEO power on firm performance should be positive due to the required demand of leadership for right direction and focus. This view is consistent with the stewardship theory (Donaldson, 1990; Muth and Donaldson, 1998) in that concentrated CEO influence may be ideal for firm performance because of the unity of leadership and clean focus it presents. The prediction for mature and late-stage firms is that the impact of concentrated CEO influence on firm performance should be negative because the mature-stage firms require more check-and-balance than power concentration. This view is rather closer to agency theory (Jensen and Meckling, 1976) in that concentrated CEO influence over the board of director is not ideal for firm value because it could compromise the necessary role of CEO monitoring. The Life-Cycle-Theory Prediction 2: For early-stage firms, we predict that stewardship theory dominates the agency theory, and therefore, the impact of CEO power concentration on firm value and performance will be positive, whereas for late-stage firms, we predict that the agency theory dominates the stewardship theory and that the association between CEO duality or plurality and firm performance is negative. In addition, because CEO power concentration is closely related to the effectiveness of board structure and other monitoring mechanism, we also focus on governance mechanism, including internal monitoring by board independence following Hermalin and Weisbach (1991, 1998, and 2003) and external monitoring by institutional investors (Jensen, 1986; Shleifer and Vishny, 1986; Allen, Bernardo, and Welch, 2001). Agency theories argue that pressures from external investors, such as institutional 44
Asia-Pacific Journal of Financial Studies (2009) v38 n1 investors, are necessary to motivate managers to maximize firm value instead of pursuing managerial objectives. Institutional investors are more willing and able to monitor corporate management than are smaller and more diffuse investors. Large shareholders, recognizing that managers have a tendency to skew decisions in directions that would benefit themselves, have an incentive to monitor managers (Demsetz and Lehn, 1985; Shleifer and Vishny, 1986). The Effectiveness of Internal/External Monitoring Prediction 3: To the extent that independent directors provide effective internal monitoring, and institutional investors provide external monitoring, we expect an inverse association between CEO power concentration and internal/external governance mechanisms, i.e., board independence and institutional ownership, and a positive association between firm value/performance and board independence and institutional ownership, after controlling for endogeneity. Obviously, however, if the board is not effective in internal monitoring (Jensen, 1993) and entrenching with CEO instead, then we will observe a positive association between CEO power concentration and board independence. 4. Research Methodology Firm value comes from two broad sources of unique features: the choice of a certain board leadership structure and corporate governance. To address this issue properly, we conduct an endogeneity correction for the treatment effects. Without correcting the endogeneity problem in which firms with a certain governance structure choose to have a particular board leadership structure to begin with, the CEO influence s contribution to firm value will be overstated (Greene, 1993). First, the choice of board leadership structure is related to certain corporate-governance mechanisms. Of two firms that appear a priori similar in prospects, the fact that one of them is involved in CEO power concentration by a management decision is evidence that the firm has a unique quality because the board leadership structure may directly influence firm value. Second, firms influenced by CEO power concentration may need effective (internal and external) monitoring because there is no clearly known effective monitoring mechanism to prevent potential managerial entrenchment of firms with CEO 45
CEO Power and Firm Performance power concentration. The regression of Tobin s q and operating performance on various governance mechanisms, firm characteristics, and a dummy variable for the choice of board leadership structure allows a first-pass estimate of whether board leadership impacts firm value. However, it may be that firms with certain leadership structures are simply of higher (or lower) quality and deliver better (or worse) performance, regardless of whether they choose specific board leadership structures. In this case, the coefficient on the CEO dummy variable might reveal a value-add, when indeed, there is none. Hence, we correct the specification for endogeneity and then examine whether the CEO dummy variable remains significant. In addition, we examine which specific board leadership structure contributes to enhance firm performance. We also use the instrumental variable (IV) method that GIM (2006) employ to deal with potential selection bias as well. Although it is not possible to correct for both endogenous treatment effects and selection bias at the same time, in order to solve the selection bias problem separately, Heckman and Robb (1985) and Moffitt (1999) suggest the instrumental variable (IV) method, which focuses on finding a variable (or variables) that influences the board leadership choice, but does not influence Tobin s q. Angrist (2000) asserts that the IV method works even when the second-stage model is nonlinear, if the researcher focuses on the causal effects. Moffitt (1999) further suggests that each IV, that is indeed uncorrelated with the random error term in the Tobin s q equation, will yield unbiased estimates. However, some IVs will yield more precise estimates. The more highly correlated the IV is with the choice of leadership, the more precise the estimates of performance impact will be. Thus the challenge in an IV estimation is to find an appropriate instrumental variable that is highly correlated with the first-pass choice, but uncorrelated with the second-pass performance. Unfortunately, it is often hard to find variables that meet both of these requirements, and therefore it is difficult to find good IVs among the many potential IVs. In our case, our choice of an instrumental variable is CEOTENURE, highly correlated with leadership choice but uncorrelated with Tobin s q. 3) 3) The Spearman correlations between CEOTENURE and board leadership choice are statistically significant while the correlations between CEOTENURE and Tobin Q and operating performance are statistically insignificant. 46
Asia-Pacific Journal of Financial Studies (2009) v38 n1 5. Empirical Results 5.1 Univariate Tests and Bivariate Correlations To examine the potential difference among the leadership choice, we compare and contrast firm and governance characteristics. In Table 2, we present the descriptive Table 2. Descriptive Statistics This table presents descriptive statistics for the whole sample of 2,681 firms during 1995 to 2005. The definitions of variables are provided in Table 1. Variable Obs Mean Median Std. Dev. 25% 75% ROA 14,085 0.027 0.041 0.196 0.012 0.079 OPPROFIT 14,086 0.125 0.125 0.116 0.071 0.181 TOBINQ 14,076 1.627 1.175 1.596 0.820 1.865 ADJTOBINQ 14,076-2.36E-09-0.172 1.393-0.588 0.219 CEOCHAIR 14,759 0.789 1.000 0.408 1 1 CEONOM 14,759 0.341 0.000 0.474 0 1 CHAIRNOM 14,759 1.920 2.000 1.019 2 3 CEOAGE 14,558 55.814 56 6.516 52 60 CEOTENURE 14,759 6.879 5 7.462 1.5 9.5 PCTCEOSHR 14,759 1.579 0.020 5.401 0 0.647 PCTDIRSH 14,759 7.195 1.126 20.236 0 6.325 LOGDIRSIZE 14,759 2.201 2.197 0.309 1.946 2.398 INDEPEN 14,759 0.647 0.667 0.192 0.5 0.8 LOGBLKS 14,759 13.961 15.696 5.373 14.671 16.583 PCTINSTI 14,759 0.615 0.638 0.199 0.482 0.767 LOGMVE 14,029 7.425 7.308 1.588 6.353 8.423 EARNINGS 14,029 1,431.419 341.700 5,981.913 101.896 1,061.747 LEVERAGE 14,054 0.242 0.230 0.192 0.082 0.354 RNDR 14,086 0.027 0.028 0.060 0 0.028 MKTBOOK 14,043 0.202 0.159 0.740-0.199 0.622 DEVRET 14,690 0.092 0.04 0.611 0.02 0.08 SEGDIV 14,759 2.468 1 1.815 1 4 FAMFIRM 14,759 0.100 0 0.300 0 0 FIRMAGE 14,114 23.342 18 18.977 9 32 SP500 14,759 0.218 0.000 0.413 0 0 CAPEX 14,086 0.054 0.040 0.057 0.019 0.071 ADVR 14,081 0.011 0 0.221 0 0.003 SALEG 14,056 13.020 8.123 40.328 0.135 19.097 DIVR 14,085 0.036 0.014 0.334 0 0.048 47
CEO Power and Firm Performance statistics of the control and governance variables. Based on the firm characteristics reported in Table 2, CEO duality measured by CEOCHAIR is, on average, 0.789 while measured by CEONOM is 0.341, suggesting that CEO and the chair of the board is more common than CEO and the chair or member of the nomination committee. The mean of CHAIRNOM is 1.920 out of 3. Thus, although not completely comparable, the normalized mean, i.e., 1.92/3, is 0.640, indicating the possibility that CEO plurality is more common than CEONOM, but less common than CEOCHAIR. The mean percentage of outside independent directors (INDEPEN) is 0.647. In our sample, the mean percentage of institutional ownership, 61.47%, is also relatively high. The family-owned firms are around 10% and the average firm age is 23.34 years. The average CEO age is 55.8 years, and their average tenure is 6.9 years, respectively. Consistent with the positive association between CEO and the chair of the board (CEOCHAIR) and board independence (INDEPEN) or the size of institutional holdings (PCTINSTI), our unreported correlation analysis suggest that CEOCHAIR is positively related to INDEPEN and PCTINSTI. Similarly, the Spearman correlation coefficient between CEONOM and INDEPEN (PCTINSTI) is relatively high in absolute numbers, at 0.19 (0.05). Likewise, the Spearman correlation coefficient between CHAIRNOM and INDEPEN (PCTINSTI) is 0.18 (0.05). All of the above correlations are statistically significant (p-values < 0.05). Both Tobin s q and adjusted Tobin s q are inversely related to the CEOCHAIR, CEONOM, and CHAIRNOM (with p-values < 0.05). 5.2 The Determinants of Board Leadership Choice Here, we develop a detailed empirical model to understand the differences among different board choice incorporating CEOCHAIR (0, 1), CEONOM (0, 1) and CHAIR- NOM (0, 1, 2, 3) as measures of board leadership. Our dependent variables of CEO duality are a dummy variable of 1 if the CEO is a chairperson of the board (CEO- CHAIR) and 0 otherwise, and a dummy variable of 1 if the CEO is a chair or a member of the nomination committee (CEONOM) and 0 otherwise. Our other dependent variable of CEO plurality (CHAIRNOM) is an ordered variable equals 0 if CEO only, 48
Asia-Pacific Journal of Financial Studies (2009) v38 n1 1 if CEONOM = 1, 2 if CEOCHAIR = 1, and 3 if CEOCHAIR = 1 as well as CEONOM = 1. 4) To examine these differences, our model relies on a probit analysis of the choice decision and ordered probit for CEO plurality, with the following model: Pr[ CEODUM Z ] = Φ [ B Z ], it it it where CEODUMit is a dummy variable equal to one if firm i has CEO duality in year t, and 0 otherwise. Zit is a vector of firm, governance, or monitoring characteristics at the time of firm i s choice of CEO duality. B is a vector of coefficients. We assert that there are characteristics of the firm and of the governance structure that lead some firms to choose a certain leadership structure, and we choose a large number of variables to model the probability of that choice. Based on the previous literature and our chosen governance metrics, we include the following variables as components of Z: Entrenchment and monitoring variables: We hypothesize that managerial entrenchment and governance mechanisms should be related to the choice of board leadership. Thus, we include managerial entrenchment index using the GIM (2003) GINDEX or Bebchuk et al. (2000) entrenchment index (ENTINDEX). To measure monitoring effect, we include internal monitoring by the percentage of director shares (PCTDIRSHR), the natural log of the sum of internal blockholdings (LOGBLKS), the percentage of outside independent directors (INDEPEN), and external monitoring by the percentage of institutional ownership (PCTINSTI). Control variables: Other control variables include firm size measured by the natural log of market value of equity (LOGMVE), R&D expenditures divided by sales revenue (RNDR), total debt divided by total assets (LEVERAGE), market-to-book value of equity (MKTBOOK), standard deviation of stock return (DEVRET), and the Fama-French 48-industry classification. Similar to GIM, we also use the family firm dummy (FAMFIRM) and the diversification dummy (SEGDIV). We choose family firms, following Anderson and Reeb (2003) and Villalonga and Amit (2006). 4) The results remain qualitatively the same when we use CEO only, 1 if CEOCHAIR = 1, 2 if CEONOM = 1, 3 and if CEOCHAIR = 1 as well as CEONOM = 1 as 4. 49
CEO Power and Firm Performance Table 3. Determinants of Board Leadership This table reports the coefficient of estimates from the probit models explaining the determinants of board leadership choices. The dependent variables are CEOCHAIR (0, 1), CEONOM (0, 1) and CHAIRNOM (0, 1, 2, 3) as measures of board leadership. The Fama-French (F-F) (1997) 48 industry is included in all Models. T-statistics are adjusted for robust and clustered (by firms) standard errors and reported in parentheses. Table 1 provides variable definition. * and ** indicate statistically significant at 1% and 5% levels. Model (1) Model (2) Model (3) Model (4) Model (5) Model (6) CEOCHAIR CEOCHAIR CEONOM CEONOM CHAIRNOM CHAIRNOM GINDEX 0.0348 0.0536 0.0470 (3.61) ** (7.73) ** (6.99) ** EINDEX 0.0524 0.0915 0.0753 (2.82) ** (6.47) ** (5.71) ** CEOAGE 0.0496 0.0498 0.0070 0.0073 0.0282 0.0284 (14.21) ** (14.25) ** (2.49) * (2.59) ** (11.77) ** (11.81) ** CEOTENURE 0.0171 0.0171 0.0132 0.0132 0.0125 0.0125 (4.00) ** (4.01) ** (4.75) ** (4.76) ** (5.27) ** (5.29) ** PCTCEOSHR 0.0228 0.0226-0.0296-0.0299-0.0055-0.0056 (3.88) ** (3.88) ** (4.78) ** (4.79) ** (1.72) (1.75) PCTDIRSHR 0.00003-0.0001 0.0064 0.0062 0.0032 0.0031 (0.04) (0.07) (5.20) ** (5.08) ** (3.84) ** (3.69) ** INDEPEN 0.5383 0.5558 1.1662 1.1771 0.8938 0.9096 (4.58) ** (4.77) ** (11.43) ** (11.53) ** (10.31) ** (10.51) ** LOGBLKS -0.0022-0.0023 0.0030 0.0031 0.0004 0.0004 (0.56) (0.59) (0.92) (0.96) (0.15) (0.14) PCTINSTI -0.0007-0.0010-0.0014-0.0019-0.0011-0.0014 (0.56) (0.78) (1.28) (1.69) (1.13) (1.51) LOGMVE 0.1489 0.1565 0.1384 0.1501 0.1547 0.1648 (8.13) ** (8.63) ** (9.28) ** (10.01) ** (11.58) ** (12.38) ** LEVERAGE 0.4619 0.4638 0.3199 0.3154 0.4130 0.4127 (3.87) ** (3.83) ** (3.10) ** (3.07) ** (4.74) ** (4.71) ** RNDR -0.3545-0.3498-0.1612-0.1539-0.3164-0.3049 (0.84) (0.83) (0.37) (0.35) (0.82) (0.80) MKTBOOK -0.2006-0.2087-0.1554-0.1655-0.1840-0.1932 (5.11) ** (5.35) ** (4.45) ** (4.75) ** (6.41) ** (6.73) ** DEVRET 0.0042 0.0029 0.0080 0.0060 0.0058 0.0041 (1.23) (0.85) (2.47) * (1.87) (2.21) * (1.55) SEGDIV 0.0067 0.0090 0.0088 0.0126 0.0087 0.0121 (0.48) (0.64) (0.79) (1.13) (0.88) (1.22) FAMFIRM -0.1776-0.1761-0.0155-0.0129-0.1129-0.1100 (2.64) ** (2.62) ** (0.24) (0.20) (2.19) * (2.13) * F-F industry yes Yes Yes Yes Yes Yes Pseudo R 2 0.1240 0.1225 0.0783 0.0761 0.0694 0.0676 Observations 13,748 13,748 13,748 13,748 13,748 13,748 In Table 3, we estimate the choice of CEO leadership using a probit function. We estimate six models with different sets of board leadership structures to compare and 50
Asia-Pacific Journal of Financial Studies (2009) v38 n1 contrast the various impacts of control variables and corporate governance variables. Consistent with the managerial entrenchment prediction 1, in all models, we find that the coefficients on GINDEX and EINDEX are significantly positive at the onepercent significance level, implying that firms with stronger managerial entrenchment are more likely to have power concentration by choosing CEO duality or CEO plurality. In addition, we find that the coefficients on CEOAGE, CEOTENURE, IN- DEPEP, LEVERAGE, and LOGMVE, suggesting that older CEO, CEO with longer tenure, a higher proportion of outside independent directors (PCTINDEP), highly financed, and bigger firm tend to opt for power concentration. Noticeably, firms with high proportion of independent board tend to choose power concentration. This finding suggests a possibility that independent board may prefer to have a strong leader for future direction. Other monitoring variables of LOGBLKS and PCTINSTI are insignificant at the conventional level, suggesting that blockholders and institutional investors monitoring is not strong enough to prevent CEO-board power concentration. We also perform logistic and ordered logit regression models for robustness check (results not reported) and the results are qualitatively the same as those of the probit and ordered probit models shown in Table 3. 5.3 The Value and Performance of Firms with Board Leadership We next examine what impact different board structure has on firm value, as measured by Tobin s q and industry-adjusted Tobin s q (ADJTOBINQ) because AD- JTOBINQ neutralizes the effect of specific industries on Tobin s q. We also examine the impact of board structure on firm performance measured by ROA and operating profit (OPPROFIT). We report several models in Table 4 using Heckman s (1979) twostage model. In model (1), following Shin and Stulz (2000), Morck and Yang (2001), and GIM (2006), we include growth options measured by R&D expenditure divided by sales (RNDR), capital expenditures divided by total sales (CAPXR), the ratio of advertising to sales (ADVR), and sales growth (SGROWTH). As shown in Table 4 above, the evidence suggests that CEOCHAIR insignificantly affects Tobin s q and industry-adjusted Tobin s q while inversely affecting ROA, and OPPROFIT after correcting for the endogenous treatment effect, indicating that the agency theory dominates the stewardship explanation in firm s operating performance when CEO has an overlapping position as the chair of the board. 51
CEO Power and Firm Performance Table 4. The impact of CEOCHAIR on firm s value and profit This table reports the coefficient of estimates from the second stage of Heckman two stage regression models explaining the determinants of firm s value and profitability measures. The dependent variables are TOBINQ, ADJTOBINQ, ROA, and OPPROFIT as measures of firm s value and profit. The Fama-French (1997) 48 industry is included in all Models. * and ** indicate statistically significant at 1% and 5% levels. Model (1) TOBINQ Model (2) ADJTOBINQ Model (3) ROA Model (4) OPPROFIT CEOCHAIR -0.0305-0.0446-0.0131-0.0071 (0.98) (1.46) (4.15) ** (3.02) ** EINDEX -0.0107-0.0103-0.0009-0.0019 (2.19) * (2.17) * (1.97) * (2.70) ** PCTCEOSHR 0.0015 0.0024-0.0004-0.0003 (0.51) (0.83) (1.12) (1.49) PCTDIRSHR 0.0015 0.0023 0.0001 0.0001 (2.30) * (3.54) ** (1.55) (1.47) LOGDIRSIZE -0.3811-0.3870-0.0191-0.0007 (7.95) ** (8.36) ** (2.02) * (0.17) INDEPEN -0.0502-0.0007-0.0008-0.0074 (0.69) (0.01) (0.09) (1.29) LOGBLKS -0.0083-0.0083-0.0011-0.0011 (3.24) ** (3.41) ** (3.62) ** (5.97) ** PCTINSTI 0.0015 0.0025 0.0010 0.0005 (1.96) * (3.32) ** (7.12) ** (8.29) ** LOGMVE 0.6173 0.5778 0.0354 0.0338 (33.72) ** (33.27) ** (14.54) ** (26.56) ** DEVRET -0.0562-0.0571-0.0095-0.0072 (3.27) ** (3.14) ** (1.77) (2.40) * LEVERAGE 0.3418 0.2655-0.0642-0.0143 (3.26) ** (2.60) ** (4.70) ** (1.13) RNDR 2.4771 2.4475-0.7963-0.7365 (3.73) ** (3.84) ** (10.73) ** (12.03) ** SEGDIV -0.0117-0.0124 0.0028 0.0012 (1.69) (1.83) (3.62) ** (2.48) * FIRMAGE -0.0035-0.0040-0.0002 0.00002 (5.25) ** (6.09) ** (2.47) * (0.99) SP500-0.0405 0.0256-0.0139-0.0085 (1.00) (0.65) (3.46) ** (3.59) ** CAPEX 1.1363 0.8887-0.0048 0.2778 (5.05) ** (3.90) ** (0.13) (10.09) ** ADVR 0.7492 1.0344-0.3904-0.0955 (1.63) (2.29) * (2.96) ** (1.74) SALEG 0.0010 0.0011-0.0004-0.0002 (1.48) (1.89) (2.43) * (3.35) ** DIVR 0.0877 0.0685 0.0080 0.0129 (3.39) ** (2.89) ** (3.62) ** (4.40) ** INTERCEPT 10.7485 9.9592 0.6251 0.6159 (22.85) ** (21.83) ** (11.76) ** (17.23) ** INVERSE-MILLS Ratio -3.3463-4.9019-0.3439-0.1925 (11.97) ** (17.18) ** (10.15) ** (9.11) ** Adjusted R 2 0.3941 0.2439 0.1682 0.3280 Observations 11,303 11,303 11,303 11,303 Number of firms 2,285 2,285 2,285 2,285 52
Asia-Pacific Journal of Financial Studies (2009) v38 n1 We also find that the higher the managerial entrenchment, the lower the firm value and firm performance, both based on GINDEX (unreported) and EINDEX, supporting the managerial entrenchment hypothesis. The coefficients on EINDEX are significantly negative, indicating that more take-over defenses through anti-takeover provisions (GINDEX) adversely affect firm value and operating performance. This result is consistent with GIM (2003) and Cremers and Nair (2005). Consistent with the prediction based on the external monitoring explanation, the coefficients on institutional ownership are significantly positive and economically meaningful in all four models of value and performance equations. However, the coefficients on independent board are insignificant. We also observe that riskier firms (DEVRET) and more levered (LEVERAGE) firms have lower firm value and operating performance. We obtain similar results of the positive association between the above four dependent variables and CEONOM when CEO has a combined position as a chair or a member of the nomination committee in an unreported results. The coefficients on lambda (inverse Mills ratio), however, are significantly negative in all four models, implying that the above results contain a sample selection bias. To remove the sample selection bias, we conduct the IV method, and the above results remain intact when we used the IV method (results unreported) as well. Table 5. The impact of CEOCHAIR on firm s value and profit based on Life-Cycle Theory This table reports the coefficient of estimates from the second stage of Heckman two stage regression models explaining the determinants of firm s value and profitability measures. The dependent variables are TOBINQ, ADJTOBINQ, ROA, and OPPROFIT as measures of firm s value and profit. CEOCHAIR1, CEOCHAIR2, CEOCHAIR3 AND CEOCHAIR4 are interactions between firms with lowest (CEOCHAIR1) to the highest (CEOCHAIR4) quartiles of Retained Earnings to Total Assets and CEOCHAIR dummy variable. POSTSOXCHAIR is an interaction between Post Sarbannes-Oxley (2002) and CEOCHAIR dummy. The Fama-French (1997) 48 industry is included in all Models. * and ** indicate statistically significant at 1% and 5% levels. Model (1) Model (2) Model (3) Model (4) TOBINQ ADJTOBINQ ROA OPPROFIT CEOCHAIR1 0.1692 0.1007 0.0030 0.0141 (3.08) ** (2.86) ** (2.59) ** (3.43) ** CEOCHAIR2 0.0129-0.0226-0.0028 0.0012 (0.25) (0.45) (0.73) (0.33) CEOCHAIR3-0.1112-0.1012-0.0220-0.0199 (2.81) ** (3.01) ** (5.29) ** (5.23) ** CEOCHAIR4-0.1409-0.1227-0.0497-0.0304 (2.40) * (2.18) * (6.61) ** (6.64) ** 53
CEO Power and Firm Performance POSTSOXCHAIR -0.0717-0.0232-0.0073-0.0036 (1.18) (0.73) (1.44) (1.38) EINDEX -0.0086-0.0088-0.0007-0.0020 (2.56) ** (2.57) ** (2.53) * (2.65) ** PCTCEOSHR 0.0009 0.0020-0.0005-0.0004 (0.18) (0.42) (1.05) (1.21) PCTDIRSHR 0.0016 0.0023 0.0001 0.0001 (1.81) (2.68) ** (1.34) (1.22) LOGDIRSIZE -0.3882-0.3877-0.0201-0.0010 (4.92) ** (4.96) ** (1.87) (0.17) INDEPEN -0.0202 0.0127-0.0014-0.0051 (0.17) (0.11) (0.13) (0.60) LOGBLKS -0.0082-0.0082-0.0010-0.0010 (2.20) * (2.24) * (2.85) ** (3.99) ** PCTINSTI 0.0022 0.0029 0.0009 0.0006 (1.96) * (2.50) * (5.85) ** (6.16) ** LOGMVE 0.6088 0.5722 0.0340 0.0326 (19.81) ** (18.98) ** (11.73) ** (15.11) ** DEVRET -0.0581-0.0586-0.0095-0.0074 (2.39) * (2.27) * (1.34) (1.81) LEVERAGE 0.4650 0.3642-0.0415 0.0037 (2.41) * (1.89) (1.97) * (0.16) RNDR 2.6844 2.5982-0.7460-0.7005 (3.14) ** (3.06) ** (7.48) ** (7.56) ** SEGDIV -0.0017-0.0049 0.0034 0.0022 (0.12) (0.36) (3.10) ** (2.24) * FIRMAGE -0.0044-0.0047 0.00001-0.0001 (3.24) ** (3.43) ** (0.20) (0.88) SP500-0.0371 0.0242-0.0155-0.0088 (0.69) (0.45) (3.37) ** (2.54) * CAPEX 0.8724 0.7188-0.0286 0.2475 (2.68) ** (2.19) * (0.67) (6.95) ** ADVR 0.6381 0.9301-0.3815-0.0988 (0.71) (1.02) (2.55) * (1.29) SALEG 0.0011 0.0012-0.0004-0.0002 (1.54) (1.92) (2.36) * (3.05) ** DIVR 0.0850 0.0664 0.0076 0.0126 (2.41) * (2.12) * (2.49) * (2.71) ** INTERCEPT 10.4168 9.7179 0.5739 0.5702 (13.66) ** (12.95) ** (8.40) ** (9.27) ** INVERSE-MILLS Ratio -3.2575-4.8362-0.3174-0.1750 (7.61) ** (12.42) ** (7.85) ** (5.37) ** Adjusted R 2 0.4000 0.2485 0.1789 0.3451 Observations 11,303 11,303 11,303 11,303 Number of firms 2,285 2,285 2,285 2,285 In Table 5, we examine the life-cycle theory and use interaction dummy variables with CEOCHAIR1, CEOCHAIR2, CEOCHAIR3 and CEOCHAIR4 between firms with lowest (CEOCHAIR1) to the highest (CEOCHAIR4) quartiles of Retained Earnings to Total Assets. To examine the impact of Sarbane-Oxley Act (SOX), we also use 54
Asia-Pacific Journal of Financial Studies (2009) v38 n1 the interaction dummy variable using POSTSOXCHAIR as an interaction between Post Sarbannes-Oxley (2002) and CEOCHAIR dummy. The results indicate that as we expected, the coefficients on CEOCHAIR1 is significantly positive in all four models, but the coefficients on CEOCHAIR2 become insignificant and the coefficients on CEOCHAIR3 and CEOCHAIR4 are all negative, suggesting the impact of CEO duality is positive in firm s early stage, but detrimental in firm s late stage. In addition, the coefficients are monotonically decreasing as life-cycle advances, strongly supporting the life-cycle theory. The coefficients on POSTSOXCHAIR, however, are insignificant, implying that the impact of SOX on firm value and operating performance is not economically significant. Table 6. The impact of CHAIRNOM on firm s value and profit This table reports the coefficient of estimates from the second stage of Heckman two stage regression models explaining the determinants of firm s value and profitability measures. The dependent variables are TOBINQ, ADJTOBINQ, ROA, and OPPROFIT as measures of firm s value and profit. The Fama-French (1997) 48 industry is included in all models. ** and * indicate statistically significant at 1% and 5% levels. Model (1) TOBINQ Model (2) ADJTOBINQ Model (3) ROA Model (4) OPPROFIT CHAIRNOM -0.0331-0.0296-0.0056-0.0037 (2.89) ** (2.64) ** (4.51) ** (3.94) ** EINDEX -0.0248-0.0229-0.0007 0.0006 (2.69) ** (2.57) * (0.65) (0.79) PCTCEOSHR 0.0026 0.0025-0.0003-0.0002 (0.93) (0.95) (1.03) (1.26) PCTDIRSHR 0.0033 0.0036 0.0003 0.0002 (4.08) ** (4.70) ** (4.12) ** (3.68) ** LOGDIRSIZE -0.6217-0.5744-0.0126-0.0209 (12.67) ** (12.13) ** (1.51) (5.33) ** INDEPEN 0.0272 0.0122 0.0024 0.0123 (0.28) (0.13) (0.27) (1.96) * LOGBLKS -0.0107-0.0110-0.0010-0.0010 (4.20) ** (4.49) ** (3.18) ** (5.90) ** PCTINSTI 0.0026 0.0032 0.0011 0.0007 (3.30) ** (4.28) ** (7.75) ** (10.28) ** LOGMVE 0.3612 0.3474 0.0154 0.0167 (25.58) ** (26.08) ** (7.66) ** (18.99) ** DEVRET -0.0174-0.0027-0.0058-0.0035 (6.25) ** (1.06) (7.51) ** (10.02) ** LEVERAGE -0.4197-0.4363-0.1086-0.0584 (4.14) ** (4.49) ** (8.65) ** (5.42) ** RNDR 5.6071 5.0338-0.4743-0.4988 (9.05) ** (8.61) ** (6.42) ** (8.16) ** SEGDIV -0.0592-0.0555-0.0004-0.0018 (8.50) ** (8.10) ** (0.57) (3.55) ** 55
CEO Power and Firm Performance FIRMAGE -0.0062-0.0057-0.0003-0.0003 (9.05) ** (8.55) ** (3.56) ** (5.53) ** SP500-0.0842-0.0273-0.0124-0.0077 (2.04) * (0.68) (3.31) ** (3.27) ** CAPEX 1.7050 1.5165-0.0005 0.3085 (6.68) ** (5.97) ** (0.01) (11.08) ** ADVR 0.0364 0.0308-0.0567-0.0500 (2.31) * (1.90) (19.62) ** (57.26) ** SALEG 0.0013 0.0012-0.0004-0.0001 (1.88) (2.13) * (2.30) * (2.71) ** DIVR 0.1120 0.0951 0.0080 0.0141 (3.25) ** (3.64) ** (4.35) ** (4.21) ** Inverse-Mills Ratio 10.2075 9.2805 1.1675 3.0293 (3.69) ** (3.56) ** (0.45) (1.67) F-F industry dummy Yes Yes Yes Yes INTERCEPT 0.9623-1.1410 0.0209 0.1015 (3.28) ** (4.03) ** (0.94) (6.01) ** Adjusted R 2 0.3388 0.1807 0.1860 0.3200 Observations 12,019 12,019 12,087 12,092 In Table 6, we report the impact of CEO plurality (CHAIRNOM) on firm value and operating performance. As anticipated, we find that too much concentration of CEO power is followed by more substantial decrease in firm value and operating performance. The coefficients on CHAIRNOM are significantly negative and economically meaningful in all four models. This evidence is in sharp contrast from the earlier results of CEO duality. Models (1) and (2) show that the results based on Bebchuk et al. (2004) entrenchment index are inversely related with TOBINQ and industry-adjusted Tobin s q, confirming the adverse effects of managerial entrenchment on firm value. More importantly, the positive relation between PCTINSTI and all four dependent variables remain significantly positive, supporting the external monitoring effect. Although unreported, OLS results are qualitatively similar to the Heckman two-stage results; moreover, the above results do not change when we run the regressions with each governance variable separately to reduce potential problems due to multicollinearity (results unreported). To solve/reduce the selection bias problem, we also conduct the tests based on the instrumental variables approach, and our unreported results, in general, closely mirror the Heckman two-stage results. The results remain robust under various specifications using the Heckman two-stage, OLS (unreported), and instrumental variables approach (unreported). 56
Asia-Pacific Journal of Financial Studies (2009) v38 n1 Table 7. The impact of CHAIRNOM on firm s value and profit based on life-cycle theory This table reports the coefficient of estimates from the second stage of Heckman two stage regression models explaining the determinants of firm s value and profitability measures. The dependent variables are TOBINQ, ADJTOBINQ, ROA, and OPPROFIT as measures of firm s value and profit. CHAIRNOM1, CHAIRNOM2, CHAIRNOM3 AND CHAIRNOM4 are interactions between firms with lowest (CHAIRNOM1) to the highest (CHAIRNOM4) quartiles of Retained Earnings to Total Assets and CHAIRNOM. POSTSOXCHRNOM is an interaction between Post Sarbannes-Oxley (2002) and CHAIRNOM. The Fama-French (1997) 48 industry is included in all models. * and ** indicate statistically significant at 1% and 5% levels. Model (1) Model (2) Model (3) Model (4) TOBINQ ADJTOBINQ ROA OPPROFIT CHAIRNOM1 0.0585 0.0514 0.0034 0.0037 (3.89) ** (3.50) ** (1.98) * (3.22) ** CHAIRNOM2-0.0086-0.0076-0.0042-0.0011 (0.58) (0.52) (2.99) ** (0.94) CHAIRNOM3-0.0660-0.0597-0.0097-0.0084 (5.87) ** (5.63) ** (6.69) ** (7.66) ** CHAIRNOM4-0.0957-0.0839-0.0180-0.0124 (6.02) ** (5.53) ** (7.73) ** (8.66) ** POSTSOXCHRNOM -0.0131-0.0095 0.0080 0.0007 (1.24) (0.94) (0.94) (0.78) EINDEX -0.0211-0.0196-0.0007 0.0008 (2.29) * (2.19) * (0.71) (1.18) PCTCEOSHR 0.0023 0.0023-0.0003-0.0003 (0.81) (0.84) (0.98) (1.41) PCTDIRSHR 0.0031 0.0035 0.0003 0.0002 (3.83) ** (4.46) ** (3.91) ** (3.40) ** LOGDIRSIZE -0.6016-0.5558-0.0085-0.0190 (12.28) ** (11.75) ** (1.01) (4.88) ** INDEPEN -0.0031 0.0079-0.0067-0.0094 (0.03) (0.08) (0.74) (1.49) LOGBLKS -0.0104-0.0106-0.0009-0.0010 (4.09) ** (4.39) ** (2.84) ** (5.51) ** PCTINSTI 0.0028 0.0034 0.0009 0.0006 (3.48) ** (4.40) ** (7.11) ** (9.89) ** LOGMVE 0.3645 0.3504 0.0155 0.0174 (25.84) ** (26.31) ** (7.68) ** (19.75) ** DEVRET -0.0117 0.0023-0.0057-0.0029 (4.18) ** (0.88) (7.01) ** (8.53) ** LEVERAGE -0.2342-0.2708-0.0868-0.0382 (2.22) * (2.67) ** (6.29) ** (3.28) ** RNDR 5.6083 5.0352-0.4513-0.4941 (9.09) ** (8.63) ** (5.96) ** (7.93) ** 57
CEO Power and Firm Performance SEGDIV -0.0479-0.0455-0.0002-0.0009 (6.89) ** (6.63) ** (0.35) (1.78) FIRMAGE -0.0068-0.0062-0.0003-0.0004 (10.09) ** (9.48) ** (4.75) ** (6.97) ** SP500-0.0903-0.0331-0.0148-0.0101 (2.17) * (0.82) (3.99) ** (4.30) ** CAPEX 1.4577 1.3011-0.0045 0.2847 (5.72) ** (5.11) ** (0.12) (10.09) ** ADVR 0.0377 0.0319-0.0561-0.0496 (2.63) ** (2.15) * (19.47) ** (55.21) ** SALEG 0.0013 0.0012-0.0003-0.0001 (1.90) (2.15) * (2.23) * (2.60) ** DIVR 0.1089 0.0923 0.0078 0.0138 (3.35) ** (3.50) ** (4.28) ** (4.33) ** INTERCEPT 0.8145-1.2711 0.0266 0.0889 (2.86) ** (4.58) ** (1.20) (5.33) ** INVERSE-MILLS Ratio 10.3291 9.3908 0.1235 0.3231 (3.73) ** (3.60) ** (0.48) (1.77) Adjusted R 2 0.3462 0.1886 0.1933 0.3338 Observations 12,019 12,019 12,019 12,019 Number of firms 2,365 2,365 2,365 2,365 In Table 7, to examine the life-cycle theory, we use interaction dummy variables with CHAIRNOM1, CHAIRNOM2, CHAIRNOM3 and CHAIRNOM4 between firms with lowest (CHAIRNOM1) to the highest (CHAIRNOM4) quartiles of Retained Earnings to Total Assets. To examine the impact of Sarbane-Oxley Act (SOX), we also use the interaction dummy variable using POSTSOXCHRNOM as an interaction between Post Sarbannes-Oxley (2002) and CHAIRNOM dummy. The results closely mirror those reported in Table 5. In particular, the coefficients on CEOCHAIR1 is significantly positive in all four models, but the coefficients on CEOCHAIR2 become insignificant and the coefficients on CEOCHAIR3 and CEOCHAIR4 are all negative, suggesting that the impact of CEO plurality is also positive in firm s early stage but detrimental in firm s late stage. In addition, the coefficients are monotonically decreasing as life-cycle advances, again strongly supporting the life-cycle theory. Similar to CEO duality case, the coefficients on POSTSOXCHRNOM are insignificant, suggesting that the impact of SOX on firm value and operating performance is not economically meaningful. 58
Asia-Pacific Journal of Financial Studies (2009) v38 n1 Table 8. The impact of entrenchment, internal and external monitoring on firm s value and profit The coefficients are estimated from the second stage of Heckman two stage regression models with interaction variables between EINDEX, INDEPEN and PCTINSTI. LOEHINDEPHINST equals to 1 if EINDEX is below the median, INDEPEN and PCTINSTI are above their medians. HIELOINDEPLOINST equals to 1 if EINDEX is above the median, INDEPEN and PCTINSTI are below their medians LOELOINDEPHINST equals to 1 if EINDEX is below the median, INDEPEN is below the median and PCTINSTI is above the median. The estimated slopes for other independent variable are similar to the results from the previous tables, therefore are not reported. Panel A: TOBINQ ADJTOBINQ ROA OPPROFIT LOEHINDEPHINST 0.0346 0.0293 0.0161 0.0063 (0.94) (0.84) (4.65) ** (2.43) * HIELOINDEPLOINST -0.0640-0.0787-0.0182-0.0073 (2.27) * (2.78) ** (2.98) ** (2.47) * Chow-test (Chi-sq) 5.23 * 6.64 ** 23.92 ** 13.09 ** Adjusted R 2 0.3376 0.1789 0.1767 0.3116 Panel B: TOBINQ ADJTOBINQ ROA OPPROFIT LOELOINDEPHINST 0.1119 0.1237 0.0136 0.0098 (2.59) ** (2.98) ** (3.60) ** (3.65) ** LOEHINDEPLOINST -0.0334-0.0359-0.0150-0.0073 (0.88) (0.95) (3.33) ** (2.52) * Chow-test (Chi-sq) 6.57 ** 8.32 ** 24.98 ** 20.13 ** Adjusted R 2 0.3380 0.1797 0.1761 0.3122 In Table 8, we report the impact of managerial entrenchment, internal and external monitoring effect on firm value and operating performance. The coefficients are estimated from the second stage of Heckman two stage regression models with interaction variables between EINDEX, INDEPEN and PCTINSTI. LOEHINDEPHINST equals to 1 if EINDEX is below the median, INDEPEN and PCTINSTI are above their medians. HIELOINDEPLOINST equals to 1 if EINDEX is above the median; INDEPEN and PCTINSTI are below their medians LOELOINDEPHINST equals to 1 if EINDEX is below the median; INDEPEN is below the median; and PCTINSTI is above the median. LOEHINDEPLOINST equals to 1 if EINDEX is below the median; INDEPEN is above the median; and PCTINSTI is below the median. HIELOIN- 59
CEO Power and Firm Performance DEPHINSTI equals to 1 if EINDEX is above the median; INDEPEN is below the median; and PCTINSTI is above the median. HIEHINDEPLOINST equals to 1 if EIN- DEX is above the median; INDEPEN is above the median; and PCTINSTI is below the median. The estimated slopes for other independent variable are similar to the results from the previous tables, therefore are not reported. Figure 1. The impact of CEO plurality and external monitoring by institutional investors on Tobin Q 2.5 2 Tobin Q 1.5 1 0.5 Chairnom0 0 Insti1 Insti2 Insti3 PCTINSTI Quartiles Insti4 Insti5 Chairnom1 Chairnom2 Chairnom3 CEO Plurality The Chow tests of which results reported in Panel A based various interaction variables suggest that the lower managerial entrenchment, higher proportion of independent directors, and higher institutional ownership case yield significantly higher firm value and operating performance than the higher entrenchment, lower independent director proportion, and lower institutional ownership case. Similarly, the Chow tests results reported in Panel B indicate that the lower entrenchment, lower independent director proportion, and higher institutional ownership case dominates the case of lower entrenchment, higher independent director proportion, and lower institutional ownership case in terms of firm value and operating performance, suggesting that the external monitoring effect by institutional investors are more impor- 60
Asia-Pacific Journal of Financial Studies (2009) v38 n1 tant than the internal monitoring by independent directors. Figures 1 demonstrates the impact of external monitoring by institutional investors on the Tobin Q in the presence of CEO plurality. As the degree of external monitoring increases, the adverse effect of increasing CEO power from CEO plurality on firm value and operating performance is significantly reduced when external monitoring by institutional investors increases. This evidence is consistent with the earlier finding reported in Tables 6 and 7. 6. Conclusions Despite the important role of board leadership and corporate governance in firm value and performance, there has been limited empirical evidence regarding this issue when firm s life-cycle changes. This paper attempts to fill the void by examining two questions: what the determinants of board leadership are and whether certain board leadership structure along with corporate governance and monitoring mechanisms enhance firm value and operating performance when firm s life-cycle advances. We analyze a comprehensive sample of firms with board leadership data in the United States during the 1995 to 2005 period. Our paper complements the existing literature on board leadership and corporate governance by making three contributions. First, we complement and extend the existing literature by examining the full determinants of board leadership structure. Consistent with our managerial entrenchment hypothesis, we find that managerial entrenchment positively affect the choice of power concentration after controlling for various firm characteristics. We also find that board independence, CEO age, and CEO tenure positively influence the choice of board leadership structure, measured by CEO duality and CEO plurality. Second, by using a two-stage approach, including the first-stage probit regressions and the second-stage Heckman regressions and instrumental variables approach, we control potential selection bias and the endogenous treatment effects between the choice of board leadership structure and firm value/performance independently. After correcting for the endogeneity bias and sample selection bias, we find that both measures of CEO duality, CEO and nomination committee member (CEONOM) and CEO and COB (CEOCHAIR), positively affect firm value and operating performance in firm s early stage while negatively affecting firm value and operating performance in firms 61
CEO Power and Firm Performance late stage. We also find that while CEO plurality -- i.e., CEO, COB, and nomination committee member or chair (CHAIRNOM), all position combined -- significantly and negatively influences firm value and operating performance, their impact on firm performance is positive in early stage and negative in mature stage. The results remain robust under various specifications including the OLS, the Heckman two-stage regressions, and the instrumental variables approach. Thus, we conclude that the lifecycle theory is strongly supported in the relation between CEO power concentration and firm performance. Third, we find that external monitoring by institutional investors is more effective to reduce the adverse effect of CEO power on firm value and operating performance compared to other governance and monitoring mechanisms. 62
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