Authors: David F. Larcker, Stanford University – Graduate School of Business; Eric C. So, Massachusetts Institute of Technology (MIT) – Sloan School of Management; Charles C. Y. Wang, Harvard Business School;
Date: January 13, 2013
Rock Center for Corporate Governance at Stanford University Working Paper, No. 84
Journal of Accounting & Economics (JAE), Forthcoming
Executive Summary from HBS:
Economists and sociologists have long studied the influence of social networks on labor markets, political outcomes, and information diffusion. These networks serve as a conduit for interpersonal and inter-organizational support, influence, and information flow. This paper studies the boardroom network formed by shared directorates and examines the implications of having well-connected boards, finding that firms with the best-connected boards on average earn substantially higher future excess returns and other advantages. Key concepts include:
- Board of director networks provide economic benefits that are not immediately reflected in stock prices.
- Firms with better-connected boards experience significantly higher future excess returns and gains in profitability compared to those with less-connected boards.
- There is a statistically significant and positive relation between board connectedness and the extent to which the firm’s realized earnings exceed the consensus analyst forecast.
- Network effects appear to be important not only in specific settings or decisions, but they have a more general impact on the economic performance of firms, particularly resource-needy firms.
Firms with well-connected (“central”) boards of directors earn superior risk-adjusted stock returns. Initiating a long (short) position in the most (least) central firms earns an average risk-adjusted return of 4.68 percent per year. Firms with central boards also experience higher future growth in return-on-assets (ROA) with analysts failing to fully reflect this information in their earnings forecasts. Return prediction, growth in ROA, and analyst forecast errors are concentrated among firms with high growth opportunities or firms confronting adverse circumstances, consistent with boardroom connections mattering most for firms that stand to benefit most from the information communicated and resources exchanged through the network of board members. Overall, our results suggest that board of director networks provide economic benefits that are not immediately reflected in stock prices.