The long and the short of director tenure

By Sim Shuzhen

SMU Office of Research & Tech Transfer – Tesla’s Elon Musk and Apple’s Steve Jobs are perhaps two of the most extreme examples of how a company’s leaders can almost come to personify the firm itself, shaping its perception in the public eye as well as its performance. Musk’s provocative tweets, for instance, have famously sent Tesla’s stock prices seesawing.

But charismatic leaders aside, companies may also be impacted by a range of other factors pertaining to its managers and directors – the structure and diversity of its board, for example, or the breadth and depth of expertise of its board members.

The relationship between a company’s upper echelons and corporate governance and performance first caught the attention of Assistant Professor Li Na, an accounting scholar at the Singapore Management University (SMU) School of Accounting, during her stints in the private sector. While pursuing academic degrees, Professor Li also worked in China as an accountant at a Fortune 500 company, and in the US as a consultant and auditor at Ernst & Young.

“I had opportunities to interact with the boards of directors and the top management of the firms’ clients. All these professional experiences stimulated my interests in gaining a deeper understanding of how the performance of boards of directors and top management affect their companies as well as the capital market as a whole,” says Professor Li, whose research interests include corporate governance, executive compensation and capital market valuation of accounting information.  

Experienced or entrenched?

In recent work done in collaboration with Assistant Professor Aida Sijamic Wahid of the University of Toronto’s Rotman School of Management, Professor Li explored the impact of the length of director tenure – how long directors hold on to their roles for – on boards’ effectiveness at monitoring the management of firms.

Researchers as well as regulators are divided over the ideal length of director tenure, says Professor Li. On one hand, longer tenures may be beneficial as they allow for knowledge continuity and boardroom collegiality; scholars have also proposed that longer tenures improve boards’ ability to implement checks and balances because longer-serving directors are less susceptible to management influence. On the other hand, some researchers take the alternative view that longer tenures preserve the status quo and lead to board entrenchment, resulting in weaker monitoring.

One strategy might be to consider what an optimal average board tenure would be, and settle on a happy medium – a length of time that minimises conflicts of interest while maximising firm-specific knowledge. But getting firms to adhere to one target is easier said than done, says Professor Li. “A downside of this approach is that any such target is necessarily stringent and therefore impractical to implement or to maintain as a policy,” she explains.  

Hence, Professor Li and Professor Wahid decided instead to consider the variation in director tenure lengths – also known as tenure diversity – among board members, rather than the average. Looking at a dataset of nearly 2,000 firms across 13 years, the researchers examined the role of tenure diversity on the assessment and disciplining of CEOs, a major function of boards of directors.  

Diversity matters

The researchers found that boards with more diverse tenure lengths were more sensitive to CEOs’ performance when deciding whether to replace them, and also less likely to overcompensate their CEOs, says Professor Li.

Further, tenure-diverse boards were less likely to be associated with accounting restatements – reflective of accounting errors – and more likely to replace their CEOs in the event of a restatement. “Our empirical findings support the hypothesis that tenure-diverse boards more effectively monitor the CEO,” summarised Professor Li.

Given that boards are also tasked with providing strategic advice to company management, the researchers further asked if tenure diversity would affect firms’ financial performance. “Despite the evidence that tenure-diverse boards are more effective at monitoring, there is no evidence that tenure diversity is associated with better future market performance and very little evidence that it is associated with better future accounting performance,” explains Professor Li. This, she added, is consistent with prior research which found that better monitoring does not indicate that boards will also be better at fulfilling their advisory roles.

Overall, the study shows that the benefits of tenure-diverse boards lie in their increased monitoring and disciplining of underperforming CEOs, says Professor Li; this may in turn stem from the boards’ mix of newer members, who are presumably more independent, and older ones, who have more firm-specific experience. The researchers published their findings in Contemporary Accounting Research, in a 2017 study titled ‘Director tenure diversity and board monitoring effectiveness’.

Accounting for technological change

In an era of unprecedented technological change, far-sighted boards of directors would do well to advise their firms to plan ahead for an uncertain future. But fast-changing economic, legislative and business environments concern academic researchers as well, says Professor Li.  

“In the area of accounting, the continuous revision of accounting regulations, the ongoing efforts to converge different accounting standards around the world, and new developments in technology have created many challenges and obstacles for accounting academic research,” she explains.

Alongside the challenges, however, the field’s swift pace also offers academics many new and exciting research opportunities, adds Professor Li. Keeping abreast of new developments in the business world helps her to continuously identify potential new topics for innovative research, she adds.  

“As technology becomes more and more integrated with our daily lives, I have become interested in how technology changes the way we conduct accounting research,” she says. “A massive amount of new data is becoming available to the researchers through innovative technologies such as cloud storage and blockchain, which now provide us powerful tools to conduct accounting research in the new era.”

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