How Law Changes Networks: A Social Network Analysis of Board Interlocks

Boards of directors, all over the world, are connected. Directors simultaneously sit on different boards and firms share directors with other firms. A substantial amount of literature has shown that the level of connectivity among directors in board interlocks has significant consequences regarding the performance and corporate governance practices of the various firms. The connections between firms via directors have been found to be a pathway for transferring information and for the propagation of practices, either positive or negative, between various firms in the market. In general, previous literature found that firms tend to have corporate governance practices similar to those of other firms with which they share directors.

The Israeli network of directors is also characterized by high concentration and connectivity. Many directors sit on numerous boards simultaneously and the boards of many firms are comprised of several interlocked directors, who sit on other firms as well. The network of directors is additionally characterized by high inter-branch connectivity, and by connections between real and financial oriented firms, while a significant portion of directors who sit on the boards of financial firms in Israel also sit as directors in real firms.

My research project empirically examines the market's reaction to increased corporate governance legal provisions which were applied to pyramid-structured corporations in Israel. Specifically, it examines the influence of legal provisions dealing with the composition of boards of directors on the intensity of board connectivity. The essence of these provisions lies in the requirement that a majority of board members be independent directors, and in the requirement that at least half of the sitting directors, minus one, be outside directors.

For the purpose of said examination, two databases were specially constructed which include detailed information regarding the boards of the largest publicly-traded firms in the Israeli market. The first database reflects the situation six months prior to the entry of the legal provisions into force, and the second database reflects the situation six months after the legislation entered into force. This data has been processed and analyzed using methodologies from the Social Network Analysis field, in order to examine the changes that occurred in various connectivity indices as a result of the legislation.

Social Network Analysis is a methodology for the discovery and analysis of social networks and relationship patterns among individuals comprising the network. This analysis reflects these connection patterns using a mathematical analysis of the relations between them, and assists in producing both quantitative results which measure relationship intensity, and visual results which enable the unprofessional observer to view the intensity of connections, and the patterns of relations.

The main findings of my analysis show that following the entry into force of the new legal provisions, the average number of directors per board has declined, and so has the average number of corporates on which a director sits. In addition, there has been a decline in the level of connectivity of the board interlocks within the large publicly-traded corporations in Israel. However, the intensity of the decline was lower than that which was expected under complete adherence to the minimal standard set in the relevant legal provisions. Furthermore, when dividing the market into groups of firms, based on shared directors, an increase in the number of different groups within the same sample of firms, and a decrease in the number of connections between groups were observable.

My research illuminates the interaction between legislative change and the market. It examines the impact of legislative change on short-term market behavior using the unique tool of Social Network Analysis. The findings of this research may serve as a basis for examining long-term legislative impacts on the spreading of different practices from one firm to another, on the connections between financial and real corporations in Israeli capital market, and on the concentration of the market itself.

Moran Ofir is Assistant Professor at the Interdisciplinary Center (IDC) Herzliya.