Presented below are descriptions of current Center for Advancing Corporate Performance projects.
CACP provides preliminary results of its research in the form of executive briefings well before journal publication, thereby making the ideas available in a timely manner while awaiting confirmation and in-depth peer review.
- Top Management Organizational Structure’s Impact on Corporate Performance
- Director Tenure Impact on Corporate Performance
- Dual Class Shares and Long-term Firm Performance
- High Frequency/High Performing Firms in the S&P 1,500
- Assessing the Impact of Human Capital Management Policies on Firm Performance
Our initial study looked at the “Disappearing COO” phenomenon. Our analysis confirmed that there is a long-term trend of eliminating the COO position in large cap firms. However, we also found that the difference in Return on Assets (ROA) during the period 1995 to 2015 for firms that have “Always had a COO” is as much as 30% greater than firms that “Never had a COO”. This conclusion calls into question the rationale for this acknowledged trend. We chose to use ROA as our metric because we believe that it most closely measures the responsibilities of the COO.
We also found a significant group of “Sometimes had a COO” firms, which is the new focus of our efforts in this area along with an effort to identify “Strong” vs. “Weak” COO’s by comparing the ratio of COO/CEO total compensation to ROA. Soon to follow will be efforts to expand these studies to the full S&P 1,500 and then to a comparison of the different financial outcomes of various compensation schemes used by functional and profit center top management teams.
Corporate governance professionals at large mutual funds, along with money managers and proxy advisors are increasingly advocating that there should be term limits on outsider corporate directors' board tenure. In this study, we examined the relationship between board tenure and corporate performance. Our analysis used Tobin's Q, a widely accepted measure of corporate performance in the finance literature, to correlate performance and average board tenure of outsider corporate directors.
By controlling for firm specific heterogeneity and incorporating the previous year’s firm performance as predictor variables, we found that outsider board tenure has little to no effect on corporate performance. Hence, current recommendations to limit board tenure are misguided. Our findings also raise the question of what other board attributes, if not director tenure, impact firm performance. An important caveat is that while the average tenure of directors does not matter to corporate performance, there is, by analogy, good reason to believe otherwise for particular directors: a 2018 study by Illinois Institute of Technology, reported in the Harvard Business Review, found that CEOs with diverse contacts lead companies that perform better—probably both as a cause and effect implying diversity of directors, too, would matter.
In December 2018, PriceWaterhouseCoopers’ (PwC) Governance distributed the results of our research in its global newsletter. These results were also featured during a panel presentation entitled “Impacts of Corporate Governance and Organizational Structure on Economic/Finance: Results—A ‘Big Data’ Approach” at the Decision Science Institute (DSI) Annual Meeting and Conference, November 2018 in Chicago. The conference is attended by 1,500 participants.
This study was suggested by Paul DeNicola who is a senior member of PwC Governance Team in New York, and a member of CACP’s Executive Advisory Board. DeNicola observed a growing level of interest among PwC’s clients about the advantages and disadvantages of dual class voting shares, especially among the “high tech” firms.
In response, CACP sponsored a study aimed at answering three important questions:
- What are the advantages and disadvantages of dual-class shares?
- When does class unification lead to better firm performance?
- Should dual-class companies consider sunset provisions at IPO?
The study identified several advantages of dual class shares, including lower takeover risk, longer CEO tenures and more investment in human capital resources, higher initial returns and higher dividends. The study also identified the misalignment in cash flow rights and voting rights between shareholders and controlling managers as a key disadvantage of dual-class shares; one that can allow controlling managers to exercise power unchecked. In addition, we found that dual-class shares firms have lower corporate cash holdings, have lower price-to-earnings and lower price-to-sales ratios, as well as higher financing costs.
A key takeaway from the analysis is that dual-class shares firms, on average, outperform single-class share firms at IPO, but four years after IPO, the valuation premium disappears, and six years after, dual-class firms tend to have a lower firm value than matched singles. These results are consistent with the leadership and management lifecycle needs of firms. Specifically, at IPO, the leadership is often seen to have the skills that are inextricably tied to firm’s value; skills that cannot be easily replicated. Thus, a dual-class shares structure is preferred. As firms mature, this leadership advantage fades, and agency costs increase. Simultaneously, many firms find they need more external capital at this stage in their lifecycle. Unification into single-class shares allows firms to raise the necessary equity, and provide a mechanism.
Thus, by setting sunset provisions firms can reap the benefits of a dual-class share structure at and following IPO, while foregoing the management entrenchment and agency problems that can arise at the later stages in firms’ life cycles. More explicitly, the dual-class structure allows controlling managers to counter the short-termism prevailing in today's financial markets, though possibly at near-term cost to investors, while a sunset provision ensures a re-alignment voting and cash flow rights under a single-class structure, likely leading to higher firm value and higher stock returns, particularly when accompanied by an equity offering.
While in its initial stages, this study has already produced some interesting findings. We rank-ordered firms by their Economic Value Added (EVA) for each year over the 15-year period ending in 2015 and identified the firms that ranked in the top 100. We then looked at the firms’ frequency distribution and found a subset of 65 firms that ranked in the top 10 for 7 or more times during this time period thus creating a small population of “Perennially Top Performers.”
The next stage of this research is to study which characteristics (related compensation, organizational structure, and/or corporate governance policies) correlate with consistently outstanding financial performance. Additional characteristics of interest include Top Management Team (TMT) compensation, CEO compensation, CEO’s slice of TMT compensation (Greed Ratio), TMT compensation as a percentage of sales, CEO compensation as a percentage of sales, as well as demographic characteristics such as CEO’s age, school attended, and highest degree earned. Importantly, we expect to identify polices that are consistent (and those that differ) across industries. Additionally, we plan to expand the current study to include other performance metrics, such as Return of Asset (R0A), Return of Equity (ROE), past return, Tobin’s Q, and Return on Invested Capital (ROIC).
The next major research undertaking for CACP will be the link human capital data to business financial performance. There exists an extensive literature on human capital management and firm performance. Much of the research relies on publicly available data (i.e., BoardEx) to study the existence of causal relationships between human capital management and firm performance metrics, such as stock returns, market valuations and future operating performance. Through partnerships with CACPs member firms, we propose to deepen the scope of human capital management studies by developing models that incorporate the wealth of data on pay, benefit and perquisites collected by partner organizations. This analysis will allow for benchmarking compensation and incentive strategies across industries to provide unmatched market intelligence.
One proposed project is to study and deepen our understanding of the relationships between the structure of the ‘Top Management Team’ and the firm’s economic and financial performance. Our aim is to investigate whether firms with strong CEOs (relative to others in the C-Suite) perform better or worse. In this setting, strength will be measured in terms of compensation distribution; we conjecture that the degree of ‘inequity’ in the TMT compensation is likely to affect the degree to which members of the top management team are a ‘true’ decision making team. Further, we want to examine under what settings the TMT structure (i.e., corporate, profit-center focused, mixed) leads to better firm performance. Available studies on the structure of the TMT are mostly anecdotal, observational and/or descriptive; lack connection to firm performance data, compensation structure, and are limited to the top 5 managers in the largest firms. The integration of available public data with the compensation and organizational structure data from CACP’s partner organizations will make possible a level of research never before undertaken and that will, in turn, lead to a significantly improved understanding of the relationship between corporate structure and performance.