This study contributes to the growing literatures on the importance of board expertise to their provision of counsel for management. By demonstrating that when announcing overseas investments, how a firm alleviates its liabilities of foreignness by board members possessing relevant experiences, the present work addresses the long-standing issue of what renders board the most effective. Drawing on expertise literature, we exam the efficacy of both director specific and heterogeneous experience, assessed by foreign market entry mode and targeted host country. The empirical results yield support for favorable impacts of both types of director experience. This finding corroborates the transition of board’s role from “passively” ratifying executive proposals, as predicted by agency theory, to “actively” instructing executives, as argued by resource dependence theory. The resource provision function of a board is further supported by greater benefits of director experience in situations of limited firm resources, assessed by executives’ associated experience. Finally, we find that directors who have operated independently from the CEO but without relevant experience cannot have significant influence on investment outcome. Our research result contributes to corporate governance research predominated by agency theory for the past decades, which presumes director independence as the foremost prerequisite for board effectiveness.
The search for board characteristics that most contribute to a firm’s success has received considerable attention from both researchers and practitioners for the past decades. Conventional corporate governance research follows agency theory, arguing that the foremost prerequisite for an effective board mechanism lies in directors’ vigilance, which prompts active and independent overseeing of management [
To advance the understanding of board function beyond the limited construct as proposed by agency theory, in this study we draw on resource dependency theory and assess the value of directors’ advisory role. The resource dependence theory has received increasing academic attention in recent years [5-7]. Highlighting a board’s counsel function, resource dependency theory contends that the level of directors’ experience and expertise plays the most critical role in determining how effective a board can be. This distinct view may complement agency theory, which pays little attention to the fact that directors can be unequal in their capabilities to provide relevant expertise because of their heterogeneous knowledge domain. We evaluate how directors’ relevant experience assists executives to contend with challenges in firms’ foreign direct investment (FDI) undertakings, a crucial firm strategy in which a board is prevalently involved1. To systematically address the implications of director experience for firms’ FDI pursuits, we first discuss the challenges of FDIs to elucidate the board’s resource provision function. We then evaluate the value of various types of director FDI experience, including those within versus those outside the focal entry mode (joint venture or acquisition) or the host country (i.e., the country where the targeted entity is located). We further test whether the presence of executives’ associated experience moderates the significance of director experience to provide further support for a board’s advisory role. We particularly focus on the value of outside directors’ experience [3,8,15], as we intend to differentiate the contribution of board members from firm executives who serve mostly as inside directors. The event study approach is applied to assess FDI outcomes, following numerous studies on corporate governance and cross border investment strategies [7,16,17].
The present study may have critical implications for corporate governance research. Although the provision of advice has been increasingly recognized as an essential form of board involvement in addition to the board’s traditional monitoring function, few researchers have empirically investigated the direct relationship between the board’s advisory role and firm performance or have examined how directors’ individual experience may enhance a board’s ability to exercise this function. This study contributes to this line of research by specifying the performance effect of director experience on a vital firm strategy: FDI. Our findings can be instructive in solving the puzzle of whether and how director experience can advance firms’ strategy outcomes, as well as in clarifying the types and conditions that director experience offers the most effective assistance to the management.
Our study may also add to international business literature. Our aim to fill this research void regarding the link between director experience and FDI outcome can be insightful, because foreign investment is theoretically perceived as a superior strategy to arbitrage product and capital market imperfections across countries [
The remainder of this paper is organized into several sections. In the next section, we review the literature and propose our hypotheses. Subsequently, we describe the sample construction and research methodology. We then report the empirical results of the study. Finally, we note conclusions and discuss our results.
International business research indicates that investment across countries is much more complex and uncertain than its domestic equivalent. Differences in national culture, customer preferences, business practices, and institutional forces increase transaction costs when conducting investment abroad [12,19,20]. Furthermore, information asymmetry in foreign markets requires great efforts from executives to adjust to local market conditions, posting significant challenges in achieving strategic objectives [21,22]. Empirical studies demonstrate consistent evidence about the greater challenges in foreign investments, where foreign acquirers tend to pay more acquisition premiums [
According to expertise literature, individuals develop expertise on complex decision makings as they accumulate substantial amounts of relevant experience in that particular field [8,26]. In contrast to general decision makings of which information can be clearly processed and critical message can be articulately identified, complex decisions are usually subject to information overload, vague cause-and-effect relation, and ambiguity of unforeseen contingencies. With feedbacks generated from numerous trial and error processes, individuals develop a more complete understanding of the underlying causeand-effect relations of a complex strategy. Through this repeated refining process, individuals enhance their capability of distinguishing critical message from unimportant ones as found in the available information pool [
Considering the challenges inherent in FDI decisions, assistance from experienced directors therefore appears crucial. However, the aforementioned expertise argument also leads to the eventuality that only a director’s FDI experience within the focal entry mode, instead of dissimilar ones, is relevant and valuable. In particular, although joint ventures (JVs) and acquisitions (ACs) are both characterized by the involvement of an ex-anti target/partner selection, negotiation process, and ex-post integration efforts, the two modes face challenges that are qualitatively different. Contrary to the partial equity investment as found in JVs, the full-investment of capital in ACs involves in-depth resource commitment, which causes investing firms to be more vulnerable to environmental uncertainty, thereby leading to higher venture risk [20,25]. Further, ACs assume full control, and thus require greater efforts from investing firms to overcome integration challenges, such as how to harmonize culture conflicts between acquiring and target firms, reconcile discrepancy of organizational systems, and prevent turnover of acquired human capital [
Hypothesis 1: A firm’s international investment performance significantly benefits from directors’ prior crossborder investment experience that has the same entry mode of focal deal, but not from that having a different entry mode.
Another essential consideration affecting the performance effect of director FDI experience relates to whether it is from the country where the current targeted entity is located (i.e., the host country). In international business research, the value of firm executives’ international experience has been noted. However, previous research has not specifically considered how difference of experience gained from disparate countries affects its value to the targeted strategy [
Hypothesis 2: A firm’s international investment performance significantly benefits from directors’ prior crossborder investment experience in the targeted host country, but not from directors’ experience outside that country.
The aforementioned arguments follow the insight of expertise research to posit that there are advantages from directors’ homogeneous experience, assessed by either entry mode or host country, that positively affect a firm’s FDI success. Although it is probable that directors’ experiential lessons dissimilar to the focal deal are of little value because of irrelevance, we develop a competing hypothesis here which states that board members’ heterogeneous experience, assessed by entry mode or host country, can be valuable in view of the transition the board’s role in setting firm strategy has had. A recent review of the board’s role indicates its gradual change from nominally rubber-stamping executives’ actions, to passively reviewing executives’ proposals, to more recently actively formulating strategies by guiding their content, context, and conduct [35,36]. The counseling role the board currently holds highlights the importance of directors possessing diverse experiences to offer executives ample strategic choices and help executives more thoroughly deliberate upon critical strategic issues, thereby optimizing a firm’s decisions. The learning accumulated through directors’ heterogeneous experiences is particularly critical in international environment than its domestic equivalent, because general problems in investments can be compounded by national cultures, language differences, political influences, and regulatory hurdles [
Hypothesis 3: A firm’s international investment performance significantly benefits from directors’ prior crossborder investment experience in non-focal host countries and in non-focal entry modes.
If directors’ experience associated with FDI decisions can enhance a firm’s FDI performance, assistance from experienced directors should bring greater gains when executives possess less FDI experience. Specifically, managers who lack FDI-related experience should be less able to foresee the achievable synergies of FDI projects, to comprehend the underlying cause-and-effect relationships of FDI decisions, and to identify applicable experiential lessons from numerous prior engagements [
Hypothesis 4: A firm’s international investment performance benefits more from directors’ cross-border investment experience when the management team has relatively less FDI experience compared with firms whose management teams have more FDI experience.
To construct our FDI sample, an initial sample of international acquisitions (IACs) and international joint ventures (IJVs) made by US corporations is taken from the Security Data Corporation’s (SDC) Mergers and Corporate Transactions database. To be selected, an IAC/ IJV must have been made by a publicly held firm and have been completed. We then search for the announcement date from both the Lexis/Nexis database (including the Business Wire, PR Newswire, Southwest Newswire, Reuters, and United Press International) and the Dow Jones News Retrieval Service database (including the Dow Jones News Wire and the Wall Street Journal) for the 2002-2008 period. We obtain board member biographical data from 14As (proxy statements), 10Ks (audited annual reports), Standard & Poors Register of Corporations, Who’s Who in America, and Dun & Bradstreet’s Reference Book of Corporate Management.
In order to be included in the final sample, the FDI deal has to meet several additional criteria. First, the common stock returns for each of the sample firms has to be available in the Center for Research on Security Prices (CRSP) daily returns files over a period beginning 200 days prior to the FDI announcement and ending 60 days following the announcement. Second, sample firms must not have made other announcements five days before or five days after the initial announcement date, in order to avoid any confounding events that could distort the measurement of the valuation effects. Third, announcing firms that have no financial and operating data from the Compustat files are deleted. Lastly, we exclude financial industries (SIC code 60 - 69) due to unavailability of data. Our final sample includes 332 IAC and 267 IJV announcements made by US firms.
To test our hypotheses, we estimate a series of hierarchical regression models that first examine the association between FDI performance and the control variables. We then sequentially enter our board experience variables and finally the moderators. The standard event-study method is used to examine stock price responses to corporate FDI announcements (our dependent variable). We follow Brown and Warner [
where is the expected return of the ith firm at time t, given the available information and the return on the market portfolio, βi measures the risk or sensitivity of the firm’s return relative to the market portfolio, and αi is the intercept. The abnormal stock returns for the FDI announcements are calculated as the residual from the actual return and an expected return generated by the market model, with parameters αi and βi estimated over a period from 200 to 60 days before the initial announcements. Day 0 in event time is the date of the publication in which the company’s initial FDI announcement appears. The two-day period (day –1, day 0) cumulative abnormal returns (CARs) for each security are measured by the deviation of the security’s realized return over the two-day period from an expected return generated by the market model. Daily stock return information is collected from the CRSP returns files. The value weighted NYSE\AMEX\Nasdaq Index is used to measure market returns.
Our independent variable, director FDI experience related to the focal entry mode, is calculated as follows. We first calculate the number of FDI cases (either IAC or IJV) individual directors have been involved in during their tenures as an executive or director of another firm over the five years preceding the announcement date. For each sample firm, we then sum the cases for all outside directors on the board to obtain a final number representing its board’s international investment experience. We exclude inside directors in the calculation to focus on a board’s unique contribution outside of what the firm’s executives can provide [3,8,15]. The following is the formula of director FDI experience:
FDI = IAC, IJVwhere FDI is the number of IAC or IJV cases that a director has been involved in when serving as a director or executive in F Company in year Y, which is within 5 years preceding the announcement date (t is the year of the investment announcement as determined by the announcement date). The number of companies that the directors serve in during this period is noted as N, and D is the number of directors that serve on the board of the focal firm. Director FDI experience cases are counted within the contexts of IACs and IJVs separately. We use a similar method to measure director FDI experience specific to the focal host country.
We also include other variables that may influence FDI performance in our model specification. First, we control for corporate executives’ IAC and IJV experience to rule out their confounding impact, since firms can alternatively learn to master overseas investments internally from executives’ related experiences. We also control influences from firm size (naturl logarithm of net sales one year prior to the announcements), firms’ growth opportunity (Tobin’ Q, which equals the average ratio of the market value of the firm’s assets to the book value of the firm’s assets for the three fiscal years before the announcement), prior performance (return on asset one year prior to the announcements), debt-to-asset ratio (the ratio of total debt to total assets one year prior to the announcements), board independence( the proportion of outside directors on boards), and year and industry dummies following literature on corporate governance and international business (e.g., [7,16,17]).