The impact of foreign board membership on firm value

Abstract

This study examines the effect of foreign (Anglo-American) board membership on corporate performance measured in terms of firm value (Tobin’s Q). Using a sample of firms with headquarters in Norway or Sweden the study indicates a significantly higher value for firms that have outsider Anglo-American board member(s), after a variety of firm-specific and corporate governance related factors have been controlled for. We argue that this superior performance reflects the fact that these companies have successfully broken away from a partly segmented domestic capital market by “importing” an Anglo-American corporate governance system. Such an “import” signals a willingness on the part of the firm to expose itself to improved corporate governance and enhances its reputation in the financial market.

Introduction

The process of globalization affects the equity value of a firm for a multiplicity of reasons. One important reason is that it removes barriers to trade and capital flows. Another, which is the focus of this paper, is because it reduces firm-level barriers to cross-border information flows and corporate governance. Historically, systematic differences between countries with regard to law and enforcement have accounted for substantial variations in financial development and performance (La Porta et al., 1997, La Porta et al., 1998, La Porta et al., 1999). This process of globalizing corporate governance systems has recently been invigorated by the general abolition of capital controls and better access to a global shareholder base (OECD, 1998; Lannoo, 1999; Aguilera and Cuervo-Cazurra, 2000).

The ongoing process of globalizing equity markets and corporate governance systems offers firms greater financial flexibility, which in turn provides them the opportunity to cut down their cost of capital by reducing cross-border information gaps and agency costs (Karolyi, 1998; Useem, 1998; Stulz, 1999; Bekaert and Harvey, 2000; Randøy et al., 2001). The removal of barriers to cross-border investment has given firms the alternative of breaking away from the corporate governance system of the country in which they have their headquarters. Essentially, the firm can opt for one of four corporate governance systems: the Anglo-American system, the German system, the Latin system or the Japanese system (see e.g., Shleifer and Vishny, 1997 and Goergen, 1998).

Corporate governance concerns the legal, institutional, and cultural mechanisms that help owners and other stakeholders to exercise control over corporate insiders and management (e.g., Shleifer and Vishny, 1997; John and Senbet, 1999; Peace and Osmond, 1999). The Anglo-American system is commonly regarded as the most demanding corporate governance system. The “superiority [in market performance] of the Anglo-American model of corporate governance” is widely recognized (see e.g., Economist, 2001, p. 32). The strict information requirements imposed by the Securities and Exchange Commission (SEC) provide further reasons for regarding the Anglo-American system in general and the US system in particular as a good proxy for the most demanding governance model.

When it comes to handling agency-cost and information problems, the reward for switching to the Anglo-American system from a less demanding arrangement appears in the shape of a lower cost of capital and a higher firm value (Stulz, 1999). The potential net gains from complying with the Anglo-American system need to be appraised after allowing for the substantial costs that compliance itself incurs. These costs arise from such factors as more extensive accounting and reporting (e.g., a second annual report in another language – English), the need for a broader and more qualified investor-relations staff, and more top management time allocated to investors (Howe and Kelm, 1987; Useem, 1998; Glaum, 2000).

This paper analyzes the potential for creating value as a result of breaking away from a partly segmented capital market. The generally recognized way of breaking away from a domestic capital market is via international cross-listing (e.g., Howe and Madura, 1990; Sundaram and Logue, 1996; Foerster and Karolyi, 1999; Miller, 1999). Here we suggest an alternative approach, i.e., signaling compliance with the Anglo-American corporate governance system by including representatives of that system on the firm’s board. Using the Anglo-American corporate governance system as the most demanding system, we emphasize the potential value that can be created by having outsider representatives of that system on the board of non-Anglo-American firms.

The empirical analysis in this study is based on companies in Norway and Sweden. The advantage of breaking away from a segmented or partly segmented capital market is likely to be the greatest for (large) companies based in small capital markets (Stulz, 1999). The existence of market segmentation or partial segmentation is due to cross-border information asymmetries and/or institutional and legal barriers. Whereas the institutional and legal barriers to foreign investment have become less of an issue in Scandinavia, cross-border information asymmetries are still very much in the picture (Dahlquist and Robertsson, 2001; Oxelheim, 2001). Companies from partly segmented capital markets such as Norway and Sweden have access to a limited domestic shareholder base that makes domestic equity expensive or even unavailable (Oxelheim et al., 1998). Consequently, we expect an assessment of companies in Norway and Sweden to show a positive firm value effect from breaking out of these partially segmented capital markets.

The paper is organized as follows. In Section 2, we discuss the attributes and implications of a global/Anglo-American corporate governance regime and describe corporate routes to compliance with that regime. The proposed relationship between Anglo-American board membership and firm value is presented in Section 3. Section 4 provides some stylized facts about corporate governance in Norway and Sweden. Section 5 describes the methodology and data. The empirical results and their interpretation are presented in Section 6. In Section 7, we summarize the key findings and suggest some managerial implications.