Aalto University Mikkeli Week 1 Session 3 9

Aalto University - Mikkeli Week 1 (Session 3): 9 -00 am – 10 -30 pm Corporate governance and firm performance Lecture Slides

Firm performance

Model Specification: 4 Equations Performance = f 1 (Governance, Ownership, Capital Structure, Industry Performance, Size, RDA Expenses, Board Size, Volatility, Treasury Stock) Governance = f 2 (Performance, Ownership, Capital Structure, RDA Expenses, Board Size, Active CEOs, Board Ownership %, Volatility) CEO Ownership = f 3 (Performance, Governance, Size, Leverage, RDA Expenses, Board Size, Volatility, CEO Tenure / CEO Age) Capital Structure = f 4 (Performance, Governance, Ownership, Size, Industry Leverage, Market-to-Book, Board Size, Volatility, Z-score)

Primary Variables Governance: • GIM G-Index • BCF E-Index • The Corporate Library Benchmark Score • BC Gov. Score • Median Director Stock Ownership • CEO-Chair Separation • Board Independence Performance: • Return on Assets (ROA) • Stock Return • Tobin’s Q Ownership: • CEO Ownership

Summary of Results – Part 1 1. Better governance leads to better current and future operating performance: Gompers, Ishii, and Metrick G-Index. Bebchuk, Cohen and Ferrell E-Index. Stock ownership of board members. CEO-Chair separation. 2. Board independence is negatively related to operating performance. 3. No measure of governance is related to future Stock Returns or Tobin’s Q. Contrary to GIM’s results. 4. Estimation method matters. There is an endogenous relationship between Governance and Performance.

Reasons for CEO Turnover

Board of Directors: Structure and composition …. . an example from Gender equality in Norway

Key questions • Are gender balanced boards a way to improve corporate performance or simply a gender equality issue? – – The role of the board Evidence on women on boards The Norwegian board gender quota Quotas in politics • Is regulatory action necessary to obtain genderbalanced boards? – Will the board gender-balance change without regulation? • Will the directive succeed in changing the genderbalance on boards of listed firms in Europe? – Is “comply or explain” enough to enforce change?

Board room gender quotas in Europe, 2012 Country Year passed Quota size Year of compliance Sanctions % female directors Norway 2003 40% 2008 yes 42% Spain 2007 40% 2015 no 11% Iceland 2010 40% 2013 yes 25% France 2011 40% 2017 yes 22% Belgium 2011 33% 2019 yes 11% Netherlands 2011 30% 2016 no 19% Italy 2011 33% 2015 yes 6% European Union Legislative proposal: 40% gender quota 14%

The role of the board of directors • Monitoring vs. giving advice • Outside vs. inside directors – More independent, but less informed about the firm • CEO turnover is more sensitive to firm performance when – – The board is dominated by outside directors (vs. insiders) The board is relatively small Directors have equity incentives The CEO is not Chairman of the board • Board characteristics and firm performance – Near impossible to attribute causality • Do certain firms chose certain boards? • Or do board characteristics affect firm performance?

Female directors and firm performance • Several studies find a positive relationship between fraction female directors or top executives and firm performance – Stock returns, ROE, ROA, ROIC, sales growth, etc. • But it is impossible to make any inferences about causality – Are profitable firms more likely to appoint women? – Or do women prefer directorships in profitable firms? • Similar issue with studies that find a correlation between gender diversity and CSR, CER, or better management practices • Little ground for claims that adding women to the board will improve firm performance

Are female directors better monitors? (Adams and Ferreira, 2009) • Gender-diverse US boards allocate more effort to monitoring –Female directors have better attendance records –Male directors have better attendance in gender diverse boards –Female directors are more likely to join monitoring committees • Audit, nominating, corporate governance • The monitoring of gender-diverse boards is manifested in higher performance-sensitivity of CEO turnover – And a higher likelihood of equity-based board compensation • Gender diversity increases firm value in firms with weak shareholder rights (where monitoring is valuable) • But it reduces the value of firms with strong shareholder rights – Could there be too much monitoring?

Board characteristics of Norwegian firms (Ahern and Dittmar, 2012) 2002 2006 2009 Number of directors 5. 5 5. 6 5. 3 Female (%) 7% 29% 43% CEO experience (%) 65% 59% 58% Higher education (%) 26% 28% 29% Age (years) 51 51 52 Tenure (years) 3. 0 2. 3 2. 6 Norwegian (%) 93% 92% 90% Board or CEO positions person 1. 4 2. 3 1. 9

Director characteristics of Norwegian firms (Ahern and Dittmar, 2012) Female Male New Exiting 46 48 50 53 CEO experience 31% 36% 64% 65% University degree 33% 30% 19% 23% CEO 16% 20% 28% 26% CFO 7% 9% 5% 3% VP 13% 14% 7% 5% Non-executive manager 15% 14% 5% 5% Consultant 14% 9% 10% Age Primary outside occupation:

Are female directors “busy” directors • Total number of board memberships for directors of Norwegian listed firms, July 2012 % of female directors % of male directors One board role 83% 89% Two-three board positions 15% 10% Four or more board positions 2% 1% Number of directorships • Female directors are often “independent” directors – 84% vs. 50% of male directors

Board of Directors: Committees

The Role of Committees of the Board of Directors The rationale for the creating of Board committees, particularly in the context of the large modern corporation l Efficiency of Board’s operations l Need to develop subject specific expertise in the Board’s operations and the desire to access particular expertise of Board members l Particularly enhancing the objectivity and independence of the Board’s judgment, insulating it from the potential undue influence of managers and controlling shareholders

The Role of Committees of the Board of Directors Establishment of committees, the appointment of members and standards of independence. The use of committees has developed largely as a matter of market practice, with laws tending to make a general market practice universal and mandatory. Legal requirements regarding the establish of committees: l National law (Companies Act, 2013) l Listing rules of the stock exchange

The Role of Committees of the Board of Directors l No general legal requirement as to the number of independent directors on the Board l Most formal requirements arise under the listing rules of the stock exchange l Sarbanes-Oxley Act of 2002, Section 301, requires the US SEC to adopt regulations to cause national securities exchanges and associations to prohibit the listing of a Foreign or US Domestic company which does not have an audit committee meeting certain standards, and establishing standards of independence for such committee members

Board Committees Standing committees l Executive Committee l Audit Committee l Compensation Committee l Nominating Committee l Public Policy Committee/Governance and Ethics Committee Ad hoc or special committees l Special Litigation Committee l Ad hoc committees formed to (i) to consider takeover or buyout offer, (ii) to investigate and advise on the appropriate response to allegations of serious misconduct against the corporation or its senior officers, and (iii) to evaluate and negotiate corporate restructurings or refinancing or other matters where conflicts of interest might otherwise arise

Audit Committee Responsibilities Audit committee oversight responsibilities can be grouped into the following categories: -Corporate governance - Internal controls - Financial reporting - Audit activities - Code of ethics conduct - Whistleblower program - Enterprise risk management - Financial statement fraud

Nominating Committee The nominating committee is usually responsible for evaluating and nominating a new director to the board, and it also facilitates the election of the new director by shareholders. The nominating committee is responsible for (1) reviewing the performance of current directors; (2) assessing the need for new directors; (3) identifying and evaluating the skills, background, diversity, and knowledge of candidates; (4) having an objective nominating process for qualified candidates; (5) assisting in the election of qualified new directors.

Compensation Committee The compensation committee is usually formed to determine the compensation and benefits of directors and executives. Structure: The committee should be composed of all independent directors who rotate periodically. Responsibilities: committees have a set of responsibilities which they need to follow stricktly. Proxy Statement Disclosure: The committee is directly responsible for ensuring that all aspects of executive compensation are fully and fairly disclosed in in the annual proxy statement. Committee responsibilities: 1. Evaluation of directors. 2. Design and implementation of director compensation plans. 3. Evaluation of senior executives. 4. Design and implementation of executive compensation plans.

Compensation Committee (Cont) Performance metrics typically used by the compensation committee include: a. Earnings per share (EPS) b. Cash flow c. Total shareholder return (TSR) d. Return metrics e. Economic profit or economic value added (EVA) f. Revenue g. Operational metrics h. Qualitative factors SEC rules require proper disclosure of executive compensation without imposing or even assessing the nature and extent of the company’s executive compensation thats why all everything the compensation committee does should be properly disclosed.

Corporate Governance Committee • The corporate governance committee should be composed of both executive and nonexecutive directors and be responsible for developing and monitoring the company’s governance principles, including the roles and responsibilities of directors and officers. • The corporate governance committee should be in charge of establishing the agenda for the company’s board of directors to determine what the board should discuss with management and to what extent. • The corporate governance committee should provide sufficient information to the board to enable it to effectively review the company’s performance. • The information should consist of both financial and nonfinancial measures of its performance, its comparison with the industry’s best practices, and the company’s budget.

OTHER BOARD STANDING COMMITTEES Public companies may form other standing or special committees to deal with issues requiring particular expertise. Examples: 1. Finance committee to oversee financial activities 2. Outside directors committee to maintain board independence 3. Executive committee to approve managements decision, plans , and actions on a behalf of entire board.