Lead Independent Directors: Good Governance or

Window Dressing?Phillip Lamoreaux

Arizona State University

Lubomir P. LitovUniversity of Arizona

Landon MaulerFlorida State University

Research Questions:

• What factors influence the choice to appoint a Lead Independent Director (LID) on a board?

• Is the LID an effective corporate governance mechanism?

• What board characteristics influence the LID effectiveness?

Empirical Findings:

• Lead independent directors are associated with higher firm value, higher excess returns, increased CEO turnover, and stronger CEO risk-taking compensation incentives.

• Evidence suggests LIDs are more effective on large boards or busy boards.

What is a Lead Independent Director?• A separate board position (in corporate charter or bylaws).

• Responsibilities include, among others, ability to call board meetings, review board meeting agendas, CEO retention and compensation, investor relations, chairing non-management meetings.

• The position is intended, in part, to elevate the prominence of the independent directors.

• Aimed to improve coordination among independent directors and to serve as liaison with the CEO and with the Board Chairman.

Albertsons, Inc.

Lead Director• Annually, at its June Board meeting, the Board appoints a

Lead Director responsible for, among other duties, coordinating the activities of the independent directors, providing the Chairman of the Board with input on agendas and Board and committee meetings and facilitating communications between the Chairman of the Board and the other members of the Board. Mr. Paul Corddry currently serves as the Lead Director.

AET – Aetna, Inc.• Michael H. Jordan, an independent Director, currently is the Presiding

Director. Generally, the Presiding Director is responsible for coordinating the activities of the independent Directors. Among other things, the Presiding Director sets the agenda for and leads the non-management and independent Director sessions held by the Board regularly, and briefs the Chairman and Chief Executive Officer on any issues arising from those sessions. The Presiding Director also acts as the principal liaison to the Chairman and Chief Executive Officer for the views, and any concerns and issues, of the independent Directors, though all Directors continue to interact one-on-one with the Chairman and Chief Executive Officer, as needed and as appropriate. The Chairman and Chief Executive Officer consults with the Presiding Director for input in setting the agenda for Board meetings and the Board meeting schedule. The Presiding Director also consults with the other Directors and advises the Chairman about the quality, quantity and timeliness of information provided to the Board and the Board’s decision-making processes.

Background:• Prior work has pointed out to the need of advocates for independent

directors on the board:• “If independent directors are to be effective, they need some form of leadership

from among their own numbers.” (Lipton and Lorsch, 1992)• Lipton and Lorsch (1992) stress such need in companies with executive

chairman or CEO-board chairman.

• In 1994, GM is the first U.S. public firm to adopt such board position. • Soon after, institutional investors seize the idea of independent board

leadership & promote to other companies.

• SOX 2002, mandated independence of the audit committee, followed by rules of listing exchanges that independent directors meet separately from insiders or executives (NYSE 2003 Governance Rules).

• SEC has acknowledged LID position in new proxy rules effective February 28, 2010

• “whether and why the company has a lead independent director, as well as the specific role the lead independent director plays in the leadership of the company.”

• “to provide more transparency about the company’s corporate governance, but are not intended to influence a company’s decision regarding board leadership structure.”

Background:

Motivation:• The incidence of such appointments have drastically increased post

NYSE Corporate Governance rules release in 2003.

• We find 915 firms among firms reporting data in ExecuComp & Board Ex, in 2008, had an (LID).

• Concerns exist with the effectiveness of LIDs and their true independence from management.

• Although the presence of LIDs is fairly common, limited academic research on the impact of LIDs on firm valuation and corporate policies.

Contributions:

• First to examine the determinants, as well as effects, of Lead Independent Directors• Specifically in terms of market valuation, performance, CEO

turnover, and CEO incentives.

• Increase understanding of how LIDs enhance board performance• Results indicate LIDs have a greater effect when

• Boards are very large.• Directors are very busy.

Independent Directors:

• Board of directors serve, in part, to reduce agency costs of a CEO.

• Chhaochharia and Grinstein (2009): find board performance improves for firms affected by SOX board independence requirements.

• Brickley, Coles, Jarrell (1997) discuss costs and benefits of CEO-Chairman duality.

• Yermack (1996): board size is inversely related to firm value.

• Fich and Shivdasani (2006): busy outside directors ineffective corporate monitors.

LID and Board Effectiveness:

• LIDs can enhance effectiveness of the board

• better board meeting planning.

• Improved communication among independent directors and executives.

• “Having a lead director energizes directors’ engagement and understanding of the company and the issues it faces. The lead director also helps to raise the quality of the materials received by directors before board meetings… directors are able to ask better questions.” (SpencerStuart, 2006.)

LID and Executive Turnover and Compensation:• LID can serve as a monitoring mechanism

• to remove poorly performing CEOs.

• to mitigate agency costs associated with dual CEO-board chairman.

• to properly align CEO incentives with shareholders.

• to monitor/remove non-executive chairmen.

Hypothesis overview:1. Good governance

• LID adoption is an attempt to improve board and firm governance.

2. Window dressing• LID’s are simply window dressing to minimize investor/

public scrutiny (neutral position).• LID designed to protect autocratic CEO from scrutiny but

not influence decision making (negative).

• Our basic research question:• Which view dominates?

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• Identify determinants for firms appointing an LID.

• LID impact on: • Corporate performance (H1)

• Profitability.• market-to-book ratio.• excess returns.

• CEO succession planning “turnover” (H2) • CEO turnover/performance sensitivity.

• CEO compensation (H3)• compensation levels.• excess compensation.• wealth sensitivity to stock volatility (Vega) and stock price

(Delta).

Hypothesis overview:

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Hypothesis Development (H1):

• LID board role may improve quality of information provided to board.

• Creates an environment where independent directors can act with autonomy.

• Greater levels of monitoring of the CEO.

• H1: Firms with an LID board role have higher profitability and higher market-to-book ratio.

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Hypothesis Development (H2):

• Better governed firms have greater CEO turnover performance sensitivities• Coughlan and Schmidt (1985), Brickley (2003), Warner, Watts & Wruck

(1988), Weisbach (1988), Murphy (1999).

• Anecdotal evidence• 71% of respondents to PWC study indicate LID involvement in CEO

succession decisions is “critical.”

• H2: IF an LID board role is an effective monitoring mechanism then, ceteris paribus, we expect higher CEO turnover/performance sensitivity.

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Hypothesis Development (H3):• If LID is an effective governance mechanism we

would expect compensation to be lower and more closely aligned with shareholder interests.• Jensen and Murphy (1990), Berger, Ofek and Yermack (1997),

Core and Guay (2002).

• H3: If LID is an effective monitoring mechanism then we expect CEOs to have stronger risk taking incentives and lower excess compensation.

Data Sources / Sample:

• Time period• 2000-2009 fiscal years.

• Datasets• BoardEx – identify LID’s from information about individual

directors.• ExecuComp – CEO compensation data.• Compustat – firm level data.• CRSP – returns.• Sample size:

• # of unique LIDs: 1,636.• Total firm year observations: 19,420.

Table 2:

Market Valuation / Performance:

Abnormal Returns:

CEO Turnover:

CEO Incentives:

Excess Compensation:

Duality Interaction:

Large Board Interaction:

Busy Board Interaction:

Conclusions:

• We document an unexplored board governance mechanism, the LID.

• LID’s are associated with higher firm performance.

• LID’s are associated with higher CEO-turnover-performance sensitivities.

• LID’s are associated with stronger risk-taking incentives for the CEO.

Future Work:

• LID and investment policy, in particular, M&A activity.

• LID and risk assessment – reliable accounting reporting.

Thank you.

First Differences Analysis:

Firm Fixed Effects: