Director Networks, Turnover, and Appointments

In case of continued poor corporate performance or retirement of executive or non-executive directors, one of the key responsibilities of the board is to contemplate the dismissal of underperforming executives and the appointment of successors. In this context, director networks are likely to play an important role. The role of social networks in job-searching has been well studied in sociology and labor economics for laborers and employees belonging to minorities, but has not been examined intensively for corporate top management. Given that close professional and social connections exist among the corporate elites, it may well be that director networks are even more important in a labor market context than employees’ connections. Contrary to many existing studies that only focus on CEO turnover, we examine turnover and succession of all board members, including the CEO, other executive directors, chairmen, and other non-executive directors. In our paper, we address the question: ‘To what extent do director networks affect the top managerial labor market?’, focusing on two types of connections within director networks, namely direct and indirect connections. The former type comprises connections between directors who are linked with one another via shared work experience, and directors gain access to local information from these direct links. Indirect connections capture the fact that directors can be connected to important directors who are themselves connected to many other directors, and are hence able to collect plenty of information from being part of the total network of directors of listed firms. Directors with superior indirect connections may acquire a global information advantage. We embed the social network methodology into our analysis of this labor market at the director level and focus specifically on two issues.

First, we examine whether, through his corporate network, a director may be able to obtain information about the top managerial labor market, which may improve the odds of finding a similar or better managerial position outside his current firm. This may be more valuable when he feels threatened by an approaching dismissal. Furthermore, a director’s network could also reflect his power or influence within the boardroom, which may affect the board’s decision on promotion and retention.

Second, we turn to the perspective of the firm, examining the board’s decision about hiring an internal versus an external candidate when a managerial or non-executive vacancy emerges. In general, an external director appointment involves more uncertainty due to asymmetric information, but the directors’ networks can mitigate this uncertainty.

Our study yields some interesting results. First, directors with better global information access (through indirect networks) are more likely to leave their current position for another firm. In contrast, executive and non-executive directors' access to local information (proxied by direct connections) does not increase the probability of their departure. Nevertheless, a director with many direct connections stands a better chance of promotion in, and retention by, his firm, because the direct connections may be a proxy for his influence or power in his firm. Second, when we investigate the factors affecting the probability of an external appointment, it turns out that outside candidates with strong indirect networks (with higher global information collection ability) are more likely to be invited to serve as directors. So, director networks grant information access, and hence enhance the directors’ labor market opportunities.

To sum up, the positive impact of indirect connections reflects the network’s information value. This signifies that the connections to people that are close and local are likely to be stronger, but then also convey much redundant information. On the contrary, connections to individuals of network importance are more efficient in terms of information acquisition and labor market performance improvement, even though such connections may only be indirect and hence weaker. We also find that a director’s labor market performance can be improved by direct connections, particularly in terms of internal promotion and retention. This implies that direct connections may provide information and power in the local environment. Overall, both direct and indirect connections are valuable in the top managerial labor market.

Luc Renneboog is Professor of Corporate Finance at Tilburg University.

Yang Zhao is Lecturer in Banking and Finance at Newcastle University Business School.