INTELLECTUAL CAPITAL OF BOARD OF DIRECTORS AS A DETERMINANT OF COMPANY PERFORMANCE
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Introduction 6
1. Intellectual capital of board of directors 8
1.1. Board of directors as one of the main internal corporate governance mechanisms 8
1.2. Intellectual capital of board of directors and its components 14
1.3. Social capital of board of directors and its measurement 18
2. Company performance: agency costs and financial indicators 24
2.1. Agency costs: definition and measurement 24
2.2. Financial indicators: market-based and accounting-based approaches 28
2.3. Relationship between intellectual capital of board of directors and firm performance 34
3. Empirical study of the relationship between intellectual capital of the board of directors and
company performance 40
3.1. Methodology and sampling 40
3.2. Econometric analysis 49
3.3. Analysis of the results and conclusions 54
3.4. Managerial implications 55
Conclusion 57
References 60
Appendices 70
1. Intellectual capital of board of directors 8
1.1. Board of directors as one of the main internal corporate governance mechanisms 8
1.2. Intellectual capital of board of directors and its components 14
1.3. Social capital of board of directors and its measurement 18
2. Company performance: agency costs and financial indicators 24
2.1. Agency costs: definition and measurement 24
2.2. Financial indicators: market-based and accounting-based approaches 28
2.3. Relationship between intellectual capital of board of directors and firm performance 34
3. Empirical study of the relationship between intellectual capital of the board of directors and
company performance 40
3.1. Methodology and sampling 40
3.2. Econometric analysis 49
3.3. Analysis of the results and conclusions 54
3.4. Managerial implications 55
Conclusion 57
References 60
Appendices 70
Starting from 2002 there appeared studies that were claiming that value of the companies is generated not only by tangible assets that are in the company, but also there is something else that generates value (Fuller, 2012). One of the possible sources is considered to be intellectual capital, and when intellectual capital is mentioned, it is attributed not only to the employees, but also to the stakeholders who might participate in the life of the company but not be necessarily involved as an employee.
When identifying possible sources of the intellectual capital, scholars refer to board of directors which is considered to be one of the most important internal mechanisms of corporate governance. Because of the importance of the board of directors and of its roles and functions, it is believed that board of directors’ composition and intellectual capital have an impact on company performance (Markarian, Parbonetti, 2007). Speaking about intellectual capital of board of directors, one can consider knowledge, experience, connections and network board members hold as constituents of their intellectual capital. Board busyness can be described as one of the characteristics that is describing intellectual capital (social capital), and average number of additional positions held by directors can be used as a measure to describe busyness.
Busyness concept has different angles: on the one hand, it can be beneficial, on the other hand, it can bring harm. Positive aspects of the concept are concluded in reputation hypothesis, according to which busy directors obtain good reputation which implies that they are valuable assets for the company (Fama, Jensen, 1983), in quality hypothesis, according to which busy directors obtain great experience and broad knowledge in different aspects (Fama, 1980) and in resource dependence theory, according to which companies need the access to the resources to be prosperous (Pfeffer, 1972), and busy directors can provide with this access through their connections and network. However, on the other hand there is busyness hypothesis which simply states that busy directors do not have enough time to properly perform their duties in all the companies they are serving for (Ferris et al., 2003).
Existing studies find evidence for both positive (Sarkar, Sarkar, 2009) and negative (Fich, Shivdasani, 2006) relationship between the busyness and company performance; some studies find evidence that there is no relationship (Arioglu, Kaya, 2015). After studying these cases, getting acquainted with different concepts connected to the board busyness, and noticing that there are almost no studies on the related topic in the Russian market, the following research question raise: is it beneficial for companies to have busy boards, in other words, is there relationship between board busyness and company performance for Russian companies?
The goal of this master thesis is to answer this question, and in order to reach the goal the following objectives are set:
• to analyze the concept of intellectual capital of board of directors;
• to examine the busyness concept as one of the components of social capital;
• to review previous studies devoted to the relationship between board busyness and company performance;
• to conduct empirical research on the relationship of board busyness and financial performance, and board busyness and level of agency costs in Russian public companies;
• to analyze the results obtained and provide managerial implications.
The thesis is organized in the following way: first chapter is devoted to description of the board of directors, its roles, functions and intellectual capital. Second chapter is more concentrated on the company performance and views it from two perspectives: as financial performance and through the level of agency costs. It is especially relevant to use agency costs to describe company performance in this case because of big role of board of directors in managing agency costs. Third chapter contains the empirical study and analysis of the obtained results with their possible managerial implications.
The empirical study examines if there is relationship between board busyness and firm financial performance (measured with the use of both accounting-based and market-based performance indicators) and also between board busyness and the level of agency costs. Study is conducted on the sample consisting of 219 Russian public companies and covering 2015-2016 period. Moreover, speaking about the board busyness, in the study it is examined both busyness of outside and inside directors, and their relation to company performance.
Obtained results suggest that there is negative relationship between board busyness and financial operating performance, non-linear relationship between busyness and market performance, and positive relationship between board busyness and the level of agency costs. These results allow to come up with recommendations for different groups of stakeholders, such as shareholders, investors, managers and regulatory authorities.
When identifying possible sources of the intellectual capital, scholars refer to board of directors which is considered to be one of the most important internal mechanisms of corporate governance. Because of the importance of the board of directors and of its roles and functions, it is believed that board of directors’ composition and intellectual capital have an impact on company performance (Markarian, Parbonetti, 2007). Speaking about intellectual capital of board of directors, one can consider knowledge, experience, connections and network board members hold as constituents of their intellectual capital. Board busyness can be described as one of the characteristics that is describing intellectual capital (social capital), and average number of additional positions held by directors can be used as a measure to describe busyness.
Busyness concept has different angles: on the one hand, it can be beneficial, on the other hand, it can bring harm. Positive aspects of the concept are concluded in reputation hypothesis, according to which busy directors obtain good reputation which implies that they are valuable assets for the company (Fama, Jensen, 1983), in quality hypothesis, according to which busy directors obtain great experience and broad knowledge in different aspects (Fama, 1980) and in resource dependence theory, according to which companies need the access to the resources to be prosperous (Pfeffer, 1972), and busy directors can provide with this access through their connections and network. However, on the other hand there is busyness hypothesis which simply states that busy directors do not have enough time to properly perform their duties in all the companies they are serving for (Ferris et al., 2003).
Existing studies find evidence for both positive (Sarkar, Sarkar, 2009) and negative (Fich, Shivdasani, 2006) relationship between the busyness and company performance; some studies find evidence that there is no relationship (Arioglu, Kaya, 2015). After studying these cases, getting acquainted with different concepts connected to the board busyness, and noticing that there are almost no studies on the related topic in the Russian market, the following research question raise: is it beneficial for companies to have busy boards, in other words, is there relationship between board busyness and company performance for Russian companies?
The goal of this master thesis is to answer this question, and in order to reach the goal the following objectives are set:
• to analyze the concept of intellectual capital of board of directors;
• to examine the busyness concept as one of the components of social capital;
• to review previous studies devoted to the relationship between board busyness and company performance;
• to conduct empirical research on the relationship of board busyness and financial performance, and board busyness and level of agency costs in Russian public companies;
• to analyze the results obtained and provide managerial implications.
The thesis is organized in the following way: first chapter is devoted to description of the board of directors, its roles, functions and intellectual capital. Second chapter is more concentrated on the company performance and views it from two perspectives: as financial performance and through the level of agency costs. It is especially relevant to use agency costs to describe company performance in this case because of big role of board of directors in managing agency costs. Third chapter contains the empirical study and analysis of the obtained results with their possible managerial implications.
The empirical study examines if there is relationship between board busyness and firm financial performance (measured with the use of both accounting-based and market-based performance indicators) and also between board busyness and the level of agency costs. Study is conducted on the sample consisting of 219 Russian public companies and covering 2015-2016 period. Moreover, speaking about the board busyness, in the study it is examined both busyness of outside and inside directors, and their relation to company performance.
Obtained results suggest that there is negative relationship between board busyness and financial operating performance, non-linear relationship between busyness and market performance, and positive relationship between board busyness and the level of agency costs. These results allow to come up with recommendations for different groups of stakeholders, such as shareholders, investors, managers and regulatory authorities.
As was already mentioned, companies right now have way bigger value compared to the value of their tangible assets, and this leads to the conclusion that there is something else inside the companies that generates value. One of the possible sources can be intellectual capital, however, there are different groups of stakeholders that can be viewed as sources of intellectual capital.
Within this master thesis board of directors was chosen as the source of intellectual capital, and it is believed that there are two types of intellectual capital board of directors provide companies with: human capital and social capital. Human capital implies knowledge, experience and skills that belong to board members, whereas social capital is about the networks and connections. Concept of multiple directorships is usually viewed from the perspective of social capital; however, the division is very relative. On the one hand, busy directors (those who hold additional directorships in the boards of other companies) have variety of experience, much knowledge and amazing skills, besides they have many connections and access to many resources; on the other hand, in case of holding too many positions, such directors might not be able to perform their duties well because of the lack of time. Advantages of busyness can be expressed as reputation hypothesis, quality hypothesis and resource dependence theory (Fama, Jensen, 1983; Fama, 1980; Pfeffer, 1972), while negative side is reflected within busyness hypothesis (Ferris et al., 2003).
Because of the ambiguity of the concept, the following question raise: is there relationship between board busyness and company performance? The goal of the thesis was to answer this question and based on the obtained results come up with managerial implications. As there is limited amount of the studies of Russian market, Russian public companies were chosen for the analysis.
First chapter of this work contains description of the boards of directors, their importance, roles and functions. Moreover, intellectual capital of the board of directors is discussed and it is shown that there is impact of the board composition and intellectual capital on company performance. Second chapter is more focused on the company performance and allows to see that there are at least two approaches to treat company performance: from the perspective of financial performance and from the perspective of agency costs. Different metrics for financial performance and agency costs are discussed in order to choose the most appropriate ones for the research. Third chapter contains empirical study conducted on the sample of 219 Russian companies within the period of 2015-2016. 3672 directors are studied and analyzed in terms of board characteristics.
The study shows that there is negative relationship between board busyness and financial operating performance, non-linear relationship between busyness and market performance, and positive relationship between board busyness and the level of agency costs, and such results allow to come up with specific managerial implications. Moreover, results show, that it is important to consider multiple directorships not for all the directors, but it is better to distinguish between outside and inside directors, and also to study the nature of the directorships held, in other words, if these directorships are held in connected or not connected companies. Saying that, if the performance is measured as return on assets, there is negative relationship between ROA and both busyness of outsiders and insiders. Every additional directorship is associated with the decrease in the return on assets. If financial performance is measured as M/B ratio, there is inverted U-shaped relationship with busyness of insiders: if insiders hold less than 5 positions, relationship is positive, and if average number of the positions is higher, relationship is negative. Besides, for the outsiders there was found non-linear relationship between the average number of the positions in not connected companies and M/B ratio. Finally, as for the agency costs, linear relationship takes place: asset turnover is negatively associated with the busyness of insiders, while share of SGA expenses is positive associated with the busyness of outsiders. Such results indicate that busyness of the board members is related to the results of the companies and should be taken into account while observing companies’ performance.
The paper contributes to the research of the board busyness in Russian companies and provides with first insights into relation between the agency costs and board busyness. As for implications, obtained results can be useful for the investors, as they can choose stocks for investments not only based on the financial analysis, but also on the corporate governance analysis. In addition, results should be useful for the shareholders especially in the situations of making decisions about the board composition or appointment of new members. Another important stakeholder are regulatory authorities, and in this case the results can become base for the recommendation to include suggections in the corporate governance code on the limit of multiple directorships number.
However, along with stated implications it is necessary to realize that there are some limitations of the study. First of all, studied period is relatively small, but as was explained in the paper, this period was chosen because of publication of new edition of corporate governance code in 2014. As time will pass, it is necessary to consider longer time period. Secondly, it is impossible to state that director’s attitude to the busyness and to additional directorships is the same: some directors can really get benefits for the company through the networks, knowledge and experience, whereas others can ignore the opportunities and just hold the positions without much of involvement. It was tried to tackle this problem at least through viewing separately positions in connected and not connected companies, however, still the limitation exists. Thirdly, nature of the companies where these directorships are held can also influence the effect on the company performance, and in current study such characteristics were not considered.
To conclude, the goal of the master thesis was reached and the empirical study of the relationship between busyness of the boards of directors in the Russian companies and their performance was conducted. Obtained results and provided implications can be useful and interesting for the shareholders, potential investors, managers and regulatory authorities.
Within this master thesis board of directors was chosen as the source of intellectual capital, and it is believed that there are two types of intellectual capital board of directors provide companies with: human capital and social capital. Human capital implies knowledge, experience and skills that belong to board members, whereas social capital is about the networks and connections. Concept of multiple directorships is usually viewed from the perspective of social capital; however, the division is very relative. On the one hand, busy directors (those who hold additional directorships in the boards of other companies) have variety of experience, much knowledge and amazing skills, besides they have many connections and access to many resources; on the other hand, in case of holding too many positions, such directors might not be able to perform their duties well because of the lack of time. Advantages of busyness can be expressed as reputation hypothesis, quality hypothesis and resource dependence theory (Fama, Jensen, 1983; Fama, 1980; Pfeffer, 1972), while negative side is reflected within busyness hypothesis (Ferris et al., 2003).
Because of the ambiguity of the concept, the following question raise: is there relationship between board busyness and company performance? The goal of the thesis was to answer this question and based on the obtained results come up with managerial implications. As there is limited amount of the studies of Russian market, Russian public companies were chosen for the analysis.
First chapter of this work contains description of the boards of directors, their importance, roles and functions. Moreover, intellectual capital of the board of directors is discussed and it is shown that there is impact of the board composition and intellectual capital on company performance. Second chapter is more focused on the company performance and allows to see that there are at least two approaches to treat company performance: from the perspective of financial performance and from the perspective of agency costs. Different metrics for financial performance and agency costs are discussed in order to choose the most appropriate ones for the research. Third chapter contains empirical study conducted on the sample of 219 Russian companies within the period of 2015-2016. 3672 directors are studied and analyzed in terms of board characteristics.
The study shows that there is negative relationship between board busyness and financial operating performance, non-linear relationship between busyness and market performance, and positive relationship between board busyness and the level of agency costs, and such results allow to come up with specific managerial implications. Moreover, results show, that it is important to consider multiple directorships not for all the directors, but it is better to distinguish between outside and inside directors, and also to study the nature of the directorships held, in other words, if these directorships are held in connected or not connected companies. Saying that, if the performance is measured as return on assets, there is negative relationship between ROA and both busyness of outsiders and insiders. Every additional directorship is associated with the decrease in the return on assets. If financial performance is measured as M/B ratio, there is inverted U-shaped relationship with busyness of insiders: if insiders hold less than 5 positions, relationship is positive, and if average number of the positions is higher, relationship is negative. Besides, for the outsiders there was found non-linear relationship between the average number of the positions in not connected companies and M/B ratio. Finally, as for the agency costs, linear relationship takes place: asset turnover is negatively associated with the busyness of insiders, while share of SGA expenses is positive associated with the busyness of outsiders. Such results indicate that busyness of the board members is related to the results of the companies and should be taken into account while observing companies’ performance.
The paper contributes to the research of the board busyness in Russian companies and provides with first insights into relation between the agency costs and board busyness. As for implications, obtained results can be useful for the investors, as they can choose stocks for investments not only based on the financial analysis, but also on the corporate governance analysis. In addition, results should be useful for the shareholders especially in the situations of making decisions about the board composition or appointment of new members. Another important stakeholder are regulatory authorities, and in this case the results can become base for the recommendation to include suggections in the corporate governance code on the limit of multiple directorships number.
However, along with stated implications it is necessary to realize that there are some limitations of the study. First of all, studied period is relatively small, but as was explained in the paper, this period was chosen because of publication of new edition of corporate governance code in 2014. As time will pass, it is necessary to consider longer time period. Secondly, it is impossible to state that director’s attitude to the busyness and to additional directorships is the same: some directors can really get benefits for the company through the networks, knowledge and experience, whereas others can ignore the opportunities and just hold the positions without much of involvement. It was tried to tackle this problem at least through viewing separately positions in connected and not connected companies, however, still the limitation exists. Thirdly, nature of the companies where these directorships are held can also influence the effect on the company performance, and in current study such characteristics were not considered.
To conclude, the goal of the master thesis was reached and the empirical study of the relationship between busyness of the boards of directors in the Russian companies and their performance was conducted. Obtained results and provided implications can be useful and interesting for the shareholders, potential investors, managers and regulatory authorities.
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