The Role of Nominating Committees and Director Reputation in Shaping the Labor Market for Directors: An Empirical Assessment

• DOI: http://doi.org/10.1111/j.1467-8683.2010.00814.x
• Published date: 01 November 2010
• Date: 01 November 2010
• Author: Aurélien Eminet,Zied Guedri

The Role of Nominating Committees and

Director Reputation in Shaping the Labor

Market for Directors: An Empirical Assessment

Aurélien Eminet* and Zied Guedri

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Do the presence and independence of nominating committees within boards of directors affect

the extent of rewards and sanctions provided by the labor market to directors with a reputation for being active in

monitoring management?corg_814557..574

Research Findings/Insights: Results drawnfrom a longitudinal sample of directors sitting on the board of 200 public French

f‌irms suggest that the stronger a director’s reputation for being active in increasing control over management, the larger the

number of his or her subsequent appointments to (1) boards with a nominating committee; (2) to boards with a nominating

committee that excludes the CEO; and (3) to boardswith a nominating committee dominated by non-executive directors. In

contrast, we found that a director’s reputation of being active in increasing control over management does not impact the

number of his or her subsequent appointments (1) to boardswithout a nominating committee; (2) to boards with a nominating

committee that includes the CEO; and (3) to boards with a nominating committee dominated by executive directors.

Theoretical/Academic Implications: This study shows that the outcome of the power struggle between the CEO and

incumbent directors during the candidate selection processdetermines the prof‌ile of directors who will ultimately obtain the

board appointment. On the one hand, independent nominating committees are likely to reduce the inf‌luence of CEOs over

the process of a director’s appointment, and therefore are likely to increase the recruitment of directors with reputations for

being active in exercising control over managers. On the other hand, nonexistence of nominating committees or presence of

weak nominating committees under the inf‌luence of the CEO decouple directors’ reputations for being active in controlling

management from the likelihood of obtaining new appointments.

Practitioner/Policy Implications: This study offers insights to policy makers interested in increasing the eff‌iciency of the

labor market for directors. More specif‌ically, it highlights the conditions under which directors with a reputation of being

active in increasing control over management are likely to be rewarded by the labor market for directors. These conditions

include (1) the creation of a nominatingcommittee; (2) exclusion of the CEO from this committee; and (3) domination of this

committee by outside directors.

Keywords: Corporate Governance, Nominating Committee, Director Reputation, France, Labor Market for Directors

INTRODUCTION

Arich stream of research in organization theory and the

sociology of corporate elites has challenged the per-

spective suggesting that directors who exercise their moni-

toring duty with due diligence are rewarded by the market

for directors while those who do not accomplish this duty

appropriately are sanctioned by the market. Indeed, several

empirical studies have shown that powerful individual

CEOs inf‌luence the director selection process by pushing for

the appointment of directors who are less likely to challenge

their decisions and by denying nomination or reelection of

directors who are likely to do so (Lorsch & MacIver, 1989;

Shivdasani & Yermack, 1999; Zajac & Westphal, 1996). Such

CEOs also facilitate the appointment of directors having

similar sociological and demographic characteristics as

themselves; since these directors are likely to exercise less

stringent control (Westphal & Zajac, 1995). Moreover,

*Address for correspondence: Catholic University of Lyon – ESDES, 23 PlaceCarnot,

69002 Lyon, France. Tel: +33472325048;Fax:+33 4 72 32 51 58; E-mail a.eminet@

univ-catholyon.fr

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Corporate Governance: An International Review, 2010, 18(6): 557–574

© 2010 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2010.00814.x

several empirical studies have indicated that social ties

among members of the elite class have a higher predictive

power on director appointment than director inclination to

increase monitoring and control over management (Davis &

Greve, 1997; Hermalin & Weisbach, 1998; Mizruchi, 1996;

Palmer, 1983; Pettigrew, 1992).

Faced with evidence indicating the ineff‌iciency of the

labor market for directors and in the context of shareholder

capitalism in which shareholders’ demands for greater

power are increasing (Davis & Thompson, 1994; Monks &

Minow, 2004), it has been necessary to reform the way in

which directors are appointed. In particular, various reports

on corporate governance stressed the need to modify the

process of director appointment through the creation of

nominating committees within boards of directors (AMF,

2004; Bouton, 2002; Cadbury, 1992; Cuervo-Cazurra & Agu-

ilera, 2004; The Combined Code, 2000; Vienot, 1995, 1999).

The mission of these specialized committees is to def‌ine the

prof‌iles of directors needed on the board and to suggest

future director candidates. The need to create nominating

committees is in line with the logic established by agency

theory (Fama, 1980; Jensen & Meckling, 1976), which under-

lines the need to separatethe f‌irm’s control and management

functions. From this perspective, nominating committees

should be able to reduce the inf‌luence of f‌irm CEOs on the

process of director selection.

Despite the widespread presence of nominating commit-

tees on corporate boards, only a few studies have examined

the impact of these committees on the functioning of the

labor market for directors. This paper attempts to f‌ill this

gap by examining whether the presence and the indepen-

dence of nominating committees moderate the relationship

between a candidate director’s reputation for increasing

control over management and the number of his or her

subsequent appointments. More specif‌ically, we suggest

that if nominating committees reduce the inf‌luence of the

CEO on the process of director selection, then it is expected

that director reputation for exercising monitoring duty

with due diligence will be positively linked to director’s

number of subsequent appointments to boards having a

nominating committee. On the other hand, such reputation

is expected to be negatively linked to or disconnected from

director’s number of subsequent appointments to boards

without a nominating committee; as the CEO’s inf‌luence

on the selection process will hinder such appointments.

However, the CEO may interfere in the designation of new

directors if the nominating committee is not independent,

for instance, if the CEO is a member of the nominating

committee or if this committee is dominated by executive

directors. Therefore, it is likely that the stronger a director’s

reputation for actively fulf‌illing the monitoring mission the

larger the number of his or her subsequent appointments

to boards in which the CEO is not a member of the nomi-

nating committee and to boards in which the nominating

committee is dominated by non-executive directors.

Conversely, such director’s reputation will be negatively

linked to or decoupled from his or her number of subse-

quent appointments to boards in which the CEO is a

member of the nominating committee and to boards in

which the nominating committee is dominated by execu-

tive directors.

We examined the moderating impact of the presence and

independence of nominating committees on the relationship

between a director’s reputation and his or her number of

subsequent appointments using a sample of 7,135 director-

year observations related to board members of 200 public

French f‌irms over the 2001–04 period. Our results indicate

that the presence and the independence of nominating com-

mittees reinforce the link between director reputation for

being active in monitoring the CEO and the number of sub-

sequent appointments. These results highlight the condi-

tions under which the labor market rewards directors

fulf‌illing their monitoring duty with due diligence, and

hence, provides incentives for directors to adopt valued

behaviors and control practices.

This paper contributes to the literature in several ways.

First, this study extends previous research by highlighting

the need to take into consideration the conditions under

which directors nominating process occurs in order to fully

understand the effect of reputation on the operation of the

labor market for directors. Indeed, our results indicate that

the outcome of the CEO-directors power struggle during

candidate selection process, captured by the presence and

independence of nominating committees, determines the

extent of association between a director’s reputation and his

or her future appointments. Therefore, our paper provides a

possible explanation for the mixed results shown in previ-

ous studies that examined gain of appointments to boards

without considering the selection context within boards.

Indeed, a number of those studies have shown that external

labor market rewards directors who exercise their monitor-

ing duty with due diligence and sanctions directors who do

not accomplish this duty appropriately. For instance, Coles

and Hoi (2003) found that non-executive directors that

rejected Pennsylvania Senate Bill 1310 antitakeover provi-

sions are nearly three times more likely to gain new board

seats than non-executive directors that retained all antitake-

over provisions. Similarly, Fich & Shivdasani (2007) found

that outside directors of f‌irms accused of fraud bear a large

decline in the number of their subsequent appointments.

However, other studies have indicated that lax directors are

not sanctioned by the external labor market and that, in

some cases, they are actually rewarded with additional

board seats. For example, Agrawal, Jaffe, & Karpoff (1999)

found little evidence suggesting that directors of f‌irms sus-

pected or charged with fraud suffer a reputational impact

reducing the number of their subsequent appointments,

while Helland (2006) found that outside directors of f‌irms

facing class action lawsuits actually increase their net

number of new board positions. Such mixed results may be

attributed to methodological considerations such as differ-

ences in the way reputation was measured or in sample

characteristics. They may, however, be also attributed to the

failure to capture the impact of the power struggle between

CEOs and directors occurring during the nomination

process. Hence, the f‌irst contribution of this study is to take

into account the balance of power between the CEO and

directors, through the presence and independence of nomi-

nating committees, in uncoveringthe reputation-subsequent

director appointments relationship.

Second, this study extends previous research thathas con-

sidered the moderating role of the context in which director

558 CORPORATE GOVERNANCE

Volume 18 Number 6 November 2010 © 2010 Blackwell Publishing Ltd