Multiple directorships of outside directors and firms’ cost behaviour: evidence from Korea

ABSTRACT

This study examines how multiple directorships of outside directors are related to firms’ cost behaviour. Results based on a sample of Korean-listed companies from 2011 to 2017 show that the level of cost stickiness is attenuated when outside directors hold multiple directorships. However, multiple directorships do not mitigate the degree of cost stickiness that is associated with managers’ strategic response to expected future sales increase. We find evidence that the degree of cost stickiness of firms with high cash holdings can be attenuated by multiple directorships. These results suggest that outside directors who serve on multiple boards are effective at monitoring cost management of empire-building managers. Further, the level of cost stickiness is not attenuated by outside directors sitting on the boards of multiple subsidiaries within the same business group. These results suggest that outside directors’ business group affiliations undermine their monitoring roles as independent directors. This study is closely related to finance and accounting literature on economic benefits of multiple directorships or board connection.

HIGHLIGHTS

• The level of cost stickiness is negatively associated with multiple directorships of outside directors.

• -Outside directors holding multiple directorships are effective at monitoring cost decisions.

• -Outside directors' business group affiliations undermine their monitoring roles.

KEYWORDS:

• Outside directors; multiple directorships; cost stickiness; business group
• Korea

ACCEPTED BY:

• Daphne Lui

Acknowledgments

The authors thank the Editor, Associate Editor and two anonymous reviewers for their helpful comments.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Chaebols, large business groups designated by the Korea Fair Trade Commission (KFTC), have at least two and at most 96 affiliated firms. Because a chaebol is defined as a group of firms in which more than 30 percent of the shares are owned by the group’s controlling shareholders, mainly the founding family and its affiliated firms; affiliated firms may not directly own shares in each other. Therefore, it is possible that outside directors sit on boards of multiple affiliated firms within the same group, despite the Commercial Act (§382) in Korea.

2 There are prior studies investigating outside directors with business ties to a firm, referred to as “grey” directors (Borokhovich et al., 2014; Hsu & Wu, 2014). Generally, grey directors are former executives, or relatives of former executives, attorneys, business consultants, and financial institution executives. Another stream of prior research examined affiliated outside directors who have social ties to firm executives (Hwang & Kim, 2009; Joh & Jung, 2018). Our definition of “intra-group” directorship is different than grey or affiliated outside directors in that we focus on their board memberships across affiliations within a business group.

3 Article 34 (Outside Directors of Listed Companies) in the Commercial Act, amended in 2013. According to Article 542-8 of the Enforcement Decree of the Commercial Act (Appointment of Outside Directors).

4 https://mk.co.kr/news/economy/view/2019/06/440830/

5 Outside directors with MULTIPLE = 1 include observations with INTRA = 1 (i.e., outside directors holding multiple directorships across affiliated members within the business group) and other directors. In our sample, there is no case in which outside directors hold directorships in more than two affiliated firms and other firms.

6 If we include firms with non-December fiscal year-end (for example, March) in the sample, we will have to make judgement regarding an outside director has multiple directorships for firms with fiscal year-end in March and December during the overlapping periods (i.e., January through March). Also, the number of firm-year observations with non-December fiscal year-end is 119, which is merely 3% of the sample. Thus, we believe that keeping these observations will not only have significant impact on the results, but also decrease the homogeneity within the sample.

7 The existing literature on cost asymmetry has taken mixed approach on whether to include two-way interactions with control variables in the estimation model. Also, the previous studies have provided mixed evidence for estimation results on EI and AI. Three-way interaction terms with EI and AI are reported insignificant (Xu & Sim, 2017), negative and insignificant (Jeong et al., 2015), or negative and positive (Lee et al., 2021), respectively. Moreover, there exist prior studies that include only AI in the regression, and they report negative (Lee et al., 2020; Jung & Lee, 2020) or positive (Choi et al., 2021) regression coefficients.

8 Future demands strength can be proxied by alternative variables such as consumer sentiment or other forecast data. However, the current study was precluded from delving into this avenue due to the data unavailability and time constraints. We anticipate that forthcoming studies will address this limitation by employing alternative proxies.

9 Untabulated test results of subsample analyses show that cost stickiness exists for firms with optimistic scenario of future sales or firms with high cash holdings, but the coefficient of DEC*▵Sales*INTRA is not significant for both subsamples based on future sales demands or corporate cash holdings.