Globalizing the Boardroom: The Impact of Foreign Directors on Firm Performance
By Jennifer Anzaldi
In a time when continuous improvements in technology have brought business from around the world to our doorsteps, corporations must consider the benefits of a globally diverse workforce and hiring managers and directors from across the globe in order to maximize profits. But what’s best for the firm?
Mason finance professor Fei Xie recently conducted research on foreign independent directors (FIDs) at U.S. firms and found that they bring both benefits and costs to firms.
With the increasing globalization of virtually all industries and marketplaces and the rising importance of emerging-market economies, an ever increasing number of U.S. companies are looking beyond their national borders for opportunities to cut costs, generate growth, and create shareholder value. In recent years, an estimated 13 percent of large U.S. public corporations have FIDs serving on their boards. FIDs can enhance the advisory capability of boards to the extent that living or working in foreign countries gives them firsthand knowledge of foreign markets and enables them to develop and tap a network of foreign contacts. These resources could allow FIDs to provide valuable insights and assistance to U.S. corporations, especially those with major foreign operations or aspirations to expand internationally.
For these companies, FIDs’ knowledge of their home countries or regions and their close connections to local business, social, and political circles can be especially beneficial. An article in the Wall Street Journal emphasizes the importance of directors’ international background and expertise, and critically points to the lower frequency of foreign directors in U.S. companies compared to European companies. According to the same article, some commentators feared that the lack of foreign directors puts U.S. firms at a competitive disadvantage in the global marketplace and could lead to poor international expansion decisions. Many U.S. companies, such as Duke Energy Corp and Hewlett-Packard Co., either have recently hired or are making efforts to hire foreign directors.
“Our analysis provides evidence that the international expertise of FIDs benefits firms with substantial foreign operations or firms making cross-border acquisitions,” says Xie, who is an assistant professor of finance at Mason’s School of Management.
However, there are some disadvantages that come with hiring foreign independent directors. Compared to domestic-based independent directors, FIDs can be less effective monitors for several reasons. First, a director’s geographic distance from corporate headquarters generates substantial oversight costs, since making on-site visits and attending board meetings (usually held at corporate headquarters) become more difficult and time-consuming. This undermines a director’s ability to gather information and closely monitor management.
Second, directors who are geographically removed from the vicinity of a firm’s corporate headquarters are cut off from local networks that provide valuable soft information. Located in foreign countries, FIDs have even fewer channels and less access to current information about the U.S. companies on whose boards they sit, and thus may be less able to stay well informed about these companies’ current operations and performance.
Third, FIDs are likely to be less familiar with U.S. accounting rules, laws and regulations, governance standards, and management methods, making it more difficult for them to evaluate managerial performance or challenge managerial decisions. These considerations suggest that FIDs likely weaken a board’s monitoring effectiveness and lead to greater agency problems between managers and shareholders. Ultimately, this weakening could lead to a poorer firm performance.
“Our findings have important implications for boards considering appointments of foreign independent directors and shareholders who must approve them,” says Xie. “Given the evidence on the monitoring deficiency of FIDs, it appears that at a minimum, a careful cost-benefit analysis is warranted to assess whether their appointments can improve firm performance and increase shareholder value. Any foreign director appointment decision needs to be well thought out, since it may have the unintended negative consequence of weakening corporate governance rather than strengthening it.”
Xie’s research interests include corporate governance, mergers and acquisitions, executive compensation, venture capital, and securities issuance. His research has been published in numerous journals including the Journal of Finance, Review of Financial Studies, Journal of Accounting and Economics, Financial Management, and Journal of Banking and Finance.
This article originally appeared on the School of Management homepage in a slightly different form.