American companies will pay members of their boards of directors for who they know because firms prize business and social connections of senior leadership, says a new study from Ball State University.
“The Price of Boardroom Social Capital: The Effects of Corporate Demand for External Connectivity,” which has been accepted for publication in an upcoming issue of the Journal of Banking and Finance, found that directors with social connections are paid more and are energetically recruited by companies.
The study’s lead author Stephen Ferris, the Bryan Dean of the Miller College of Business at Ball State, notes that business and social connections are valued by firms because the two primary responsibilities of directors for a public corporation are to monitor and advise management.
“These senior leaders are hired because of the value they provide,” he said. “We find strong evidence that the social and business connections of corporate directors are factored into their pay. That is because these increased director connections can lead to new contracts, attract better financing, or provide strategic information that can generate profitable business opportunities.”
Ferris found that that increased social connections of directors can increase annual total compensation of a director by as much as $20,550 or about 17 percent of overall compensation.
Also, the study found that firms pay a premium for within-industry connections.
He also notes that the study provides the first direct evidence that a previously unidentified factor, boardroom social capital, defined as network derived from directors’ personal associations with corporate executives or directors of other firms, significantly affects director compensation and its components.
Such companies also place a strong emphasis on such relationships during challenging times, Ferris also found.
In the study, researchers examined three adverse events that can happen to a company: a bad merger, performance decline, or a cut in dividends. They then examined whether the companies that suffer these problems hire directors that are better connected.
“Across all three events, companies tend to increase the number of directors with social connections while paying more to their boards,” Ferris said. “Companies increase the breadth of their social and business connections when they get into trouble. They hire better connected directors. We also find that these connected directors tend to sit on a lot of other boards because of their connections. Companies believe that who directors know might be as important as what they know.”
Researchers found these conclusions by examining a large dataset of 9,000 firm-year observations during 2007-2013.
Visit the Miller College of Business website for more information.