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Preoccupied firm directors

One-fifth of independent directors are ‘distracted’ each year by various issues, and this harms firm valuation, operating performance and M&A deal profitability, says new study by Professor Ronald W. Masulis, the Pembroke Visiting Scholar at Cambridge Judge Business School.

Thoughtful businesswoman looking away with cup of coffee

Previous studies on the value of independent company directors have been decidedly mixed, some finding a positive link to corporate outcomes while others finding no effect at all.

A new study co-authored by the Pembroke Visiting Scholar at Cambridge Judge Business School, Ronald W. Masulis, takes a different look at the role of independent directors – focusing on how outside “distractions” of independent directors can impact firm performance.

The study finds that about 20 per cent of company independent directors are “preoccupied” or distracted each year by various personal or professional issues ranging from illness or winning major awards, to nagging problems at other companies where they also serve as a director such as CEO turnover.

Firms with more distracted directors suffer from declining valuation and operating performance, and weaker merger and acquisition (M&A) profitability and accounting quality, concludes the study forthcoming in the Journal of Financial Economics, based on Standard & Poor 1500 firms over the period 2000 to 2013.

In addition, distracted directors are more likely to miss board meetings (weakening monitoring capability), have a lower trading frequency in the firm’s stock (trading behavior should reflect a director’s current knowledge of the firm), and are more likely to unexpectedly leave the board within the next two years (suggesting less motivation to devote time to board responsibilities).

While the study looks at conflicting board roles, it also examines distractions for directors who sit on a single board – thus showing that competing time commitments are hardly the only distraction for independent directors that impede firm performance. The study’s final firm-level sample contains 15,524 firm years and 93,665 independent director-year observations (an average board has nine directors, seven of them independent).

“Our findings highlight the fact that not all independent directors are fully engaged, and only non-distracted independent directors consistently add value,” the study says. “This may be a major reason why many prior studies of board independence yield insignificant or contradictory results.” The findings do not extend to distracted affiliated directors.

The study – entitled “How valuable are independent directors? Evidence from external distractions” – is co-authored by Professor Ronald W. Masulis and Dr Emma Jincheng Zhang of the University of New South Wales in Australia. Professor Ronald W. Masulis is the current Pembroke Visiting Scholar at Cambridge Judge Business School, working closely with the business school’s Finance subject group.

“A distracted independent director simply stops supplying the same level of advising and monitoring services previously provided, yet they are usually not replaced,” the study says. “The severity of a distraction’s impact varies with its duration and the relative importance of a director’s role.”

Regarding M&A activity, the study says that if one or more independent directors are distracted, they are less likely to review “an extensive array” of legal documents provided by management or advise on deal negotiation and integration. The paper looked at 2,659 deals, finding that distracted directors “leads to significantly lower acquisition announcement returns, which can reflect lower acquisition quality or overbidding or both.”

Pembroke Visiting Scholars have been welcomed at Cambridge Judge since 2012 to allow senior faculty active in finance to visit the business school for periods up to six months. Holders of the post are admitted to Pembroke College, one of the Colleges of the University of Cambridge, where they join in meals and other events at the College.