When do firms benefit from affiliated outside directors? Evidence from Korea

• Author: Jin‐Young Jung,Sung Wook Joh
• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/corg.12224

EMPIRICAL

When do firms benefit from affiliated outside directors?

Evidence from Korea

Sung Wook Joh

1

|Jin‐Young Jung

2

1

College of Business Administration, Seoul

National University, Seoul 151‐716, South

Korea

2

College of Business Administration, Inha

University, Incheon 22212, South Korea

Correspondence

Sung Wook Joh, College of Business

Administration, Seoul National University,

Seoul, 151‐716 South Korea.

Email: swjoh@snu.ac.kr

Jin‐Young Jung, College of Business

Administration, Inha University, Incheon

22212, South Korea.

Email: jyjung@inha.ac.kr

Funding information

Institute of Finance and Banking, Seoul

National University; Institute of Management

Research, Seoul National University

Abstract

Manuscript Type: Empirical: Research Question/Issue: Directors can serve

different roles: advisors, liaisons, or monitors. Affiliated outside directors have social or busi-

ness/financial ties to firm executives, are often more trusted than others by the latter, have more

knowledge of the firm, give better advice, or liaise more effectively with other organizations.

However, they monitor less effectively than other outside directors do. This study theoretically

predicts and empirically examines whether affiliated outside directors' contributions to firm

value are moderated by corporate conditions: external control threats, uncertainty, government

regulation, or information asymmetry.

Research Findings/Insights: Panel data analysis shows that among firms that are

standalone, have M&A threats, suffer financial distress, face financial uncertainty, or are subject

to stricter government regulations, those with more affiliated outside directors—especially those

with social ties—have greater firm value. In low information asymmetry environments, firms with

more affiliated outside directors have lower firm value. In high information asymmetry environ-

ments, however, firms with more independent outside directors have lower firm value. These

results remain robust after controlling for endogeneity issues of board composition, outside

directors' human capital, social capital, CEO attributes, firm attributes, and industry attributes.

Theoretical/Academic Implications: This study extends and links resource dependence

theory and agency theory by showing how outside directors with social ties and those with busi-

ness ties are related to firm value. Furthermore, the value of affiliated outside directors' resources

and liaisons differ across corporate conditions, which extends resource dependence theory. Also,

effective monitoring by unaffiliated outside directors requires sufficient access to firm informa-

tion, which extends agency theory.

Practitioner/Policy Implications: The relations of different outside directors to firm value

across corporate conditions suggest that firms can benefit from considering their corporate con-

ditions when designing the composition of their board of directors.

KEYWORDS

Corporate Governance, Board Composition, Connected Outside Directors, Roleof Outside

Directors, Monitoring and Advising

1|INTRODUCTION

Boards of directors perform multiple functions (Hillman & Dalziel,

2003; Johnson, Daily, & Ellstrand, 1996). According to resource depen-

dence theory (Hillman, Cannella, & Paetzold, 2000; Pfeffer & Salancik,

1978), directors can provide expertise, advise, confer legitimacy, or

liaise with key people/resources outside the firm (external

environment), while according to agency theory (Fama & Jensen,

1983), directors can protect shareholders' interests by monitoring man-

agement decisions and outcomes. Compared to other outside directors,

affiliated outside directors (AODs) with social ties to firm insiders or

business/financial ties to their firm, have more firm information, opera-

tional expertise, and social incentive(s) to help firm executives, so AODs

can give firm‐specific advice, be entrusted to implement it, and liaise

Received: 5 May 2016 Revised: 25 June 2017 Accepted: 13 August 2017

DOI: 10.1111/corg.12224

Corp Govern Int Rev. 2018;26:397–413. © 2017 John Wiley & Sons Ltdwileyonlinelibrary.com/journal/corg 397

and negotiate with external organizations more effectively (Adams &

Ferreira, 2007; Westphal, 1999). According to agency theory, indepen-

dent outside directors (IODs) are the best monitors of top management.

In contrast, AODs can have conflicts of interest related to agency issues

(Weisbach, 1988), adopt poorer corporate governance practices

(Brickley, Coles, & Terry, 1994; Cheung, Chung, Tan, & Wang, 2013),

are more likely to commit financial fraud (Beasley, 1996), and pay

higher compensation to CEOs, controlling for firm value (Hwang &

Kim, 2009). These studies suggest a tension between the resource‐

providing advising or liaising roles versus the monitoring role (Baysinger

& Hoskisson, 1990; Goranova & Ryan, 2015; Hillman & Dalziel, 2003;

Kim, Mauldin, & Patro, 2014) in AODs. Hence, whether the benefits

of AODs' outside ties and superior resources outweigh the costs of

their weaker independence might depend on the specific situation.

Past studies suggest that the effectiveness of AODs in their

resource‐providing and monitoring roles differ, but few studies have

systematically evaluated AODs' relations to firm value across different

corporate conditions/environments according to their different roles.

For example, research has shown that facing large environmental

uncertainty, such as stock return volatility, firms can ask AODs for rel-

evant advice or liaise with firms with useful resources (Dass, Kini,

Nanda, Onal, & Wang, 2014; Lang & Lockhart, 1990; Pfeffer &

Salancik, 1978). Other studies show that external corporate control

threats discipline firm executives, thereby reducing the need for inter-

nal monitoring (Jensen & Ruback, 1983). Among such targeted firms,

those firms with AODs receive higher premiums than those without

them, suggesting effective AOD advice (Schmidt, 2015). Also, firms

with AODs are more likely than other firms to re‐emerge from bank-

ruptcy, suggesting effective AOD advice or AOD liaising with govern-

ment/banks (Arora, 2016). In firms under heavy regulations or seeking

government contracts, politically‐connected directors can liaise with

government agencies (Agrawal & Knoeber, 2001; Goldman, Rocholl,

& So, 2013; Joh, Chiu, & Cho, 2017; Pfeffer, 1972; Siegel, 2007).

Moreover, when outside directors have difficulty getting information

on firms and have less information than insiders (i.e., information asym-

metry), they do not monitor well and do not improve firm value

(Duchin, Matsusaka, & Ozbas, 2010). These past studies suggest that

AODs might especially benefit firms facing external control threats,

uncertainty, financial distress, government regulation/intervention, or

information asymmetry environments. Therefore, we ask this broad

question: how do different firm‐level conditions affect AODs' use of

their advising and liaison skills to enhance firm performance?

Unlike past studies that examined each role in isolation from cor-

porate conditions, we adopt a contingency approach to identify the

corporate conditions that allow AODs to leverage their advising and

liaison skills—the issues of resource dependency for greater firm value.

We test whether firms with proportionally more AODs with social ties

or with business ties under the above corporate conditions show

higher firm value using suitable data. Our 3,836 observations of

Korean firms include various board structures in many different corpo-

rate environments after the 1997 economic crisis, specifically during

1999–2006: stock market volatility, financially distressed firms,

mergers and acquisitions (M&As), government regulations, and infor-

mation asymmetry. In 1999, government regulations required Korean

firms to hire more outside directors (Black & Kim, 2012). So, firms

increased their proportion of outside directors, from 12% of boards

in 1999 to 37% in 2006; in contrast to the proportion of outside direc-

tors in US firms, namely 72% in 1999 and 81% in 2007 (Booth,

Cornett, & Tehranian, 2002; Spencer Stuart Board Index). Facing

increasing pressure to appoint more outside directors, firms appointed

a substantial portion of outside directors with social or financial ties.

Hence, these data from Korean firms with different board structures

and environmental contingencies appear well‐suited to testing links

between AODs and firm value across different corporate conditions.

Our results show that corporate conditions moderate outside

directors' relations to firm value. When facing external control threats,

greater stock market volatility or more government regulations, firms

with proportionally more AODs (especially those with social ties to

firm executives) have higher firm value than other firms. In high infor-

mation asymmetry environments, firms with more independent out-

side directors have lower firm value. These results remain robust

after controlling for endogeneity issues of board composition, outside

directors' human capital, their social capital, CEO attributes, firm attri-

butes, and industry attributes. Hence, these results suggest that firms

try to reduce environment uncertainties and dependencies through

AODs (Pfeffer & Salancik, 1978). They also suggest that recognizing

differences among outside directors and firm environments can

improve our theoretical understanding of the mechanisms by which

boards affect firm value and their scope conditions.

Our study contributes to the research on boards of directors in

four ways. First, our study connects resource dependence theory and

agency theory by showing how the value of outside directors' advising,

liaising, and monitoring vary across different corporate conditions,

which moderate the links between outside directors and firm value.

Second, our study extends agency theory by showing that effective

monitoring by independent outside directors requires sufficient access

to information. Third, our study highlights attributes of affiliated out-

side directors, specifically social ties and business ties, and shows their

different relations to firm value across corporate conditions, especially

under external control threats. Lastly, the different relations of AODs

to firm value across various environments suggest that firms can

benefit from considering their corporate conditions when designing

the composition of their board of directors, specifically regarding types

of outside directors.

The rest of this paper is organized as follows. Next, we review the

previous research and develop our hypotheses, followed by a descrip-

tion of our data and the variables. Then we test our hypotheses regard-

ing outside directors' relations to firm value across different corporate

conditions and discuss the results. We conclude in the final section.

2|AFFILIATED OUTSIDE DIRECTORS AND

CORPORATE CONDITIONS

After a brief definition of boards of directors and their members, we

discuss their key attributes and functions. Then, we examine their

effectiveness at advising, liaising and monitoring. Next, we discuss

how their efforts in these three roles are amplified in environments

with external control threats, high uncertainty, government regula-

tions, or information asymmetry.

398 EMPIRICAL