Are overextended corporate board members costing investors money?
Credit Suisse maintains limiting board seats can boost returns for investors
Should a corporate director be a one-company board member?
There’s one question shareholders are asked every year: Who should sit on the company’s board of directors?
It’s a matter many smaller investors may ignore, figuring that their vote won’t carry any weight, given that they hold relatively few shares. But there is strength in numbers: If all shareholders take an interest in the makeup of the board that oversees the company they own, the result could be much better long-term results.
And the number of board seats held by each director just may offer clues about how the stock will perform. A team of analysts at Credit Suisse led by Julia Dawson say their analysis suggests the best answer may be just one board.
This is hardly a consensus view, beginning with whether one seat is the optimal number. Indeed, only 5% of S&P 500 companies limit their board members to serving only two boards, and none restrict them to just one board, according to Lori Ryan, director of the Corporate Governance Institute at San Diego State University.
Institutional Shareholder Services Inc., which provides proxy advisory services to investors, takes a more expansive view. It recommends shareholders vote “no” to the election of directors who serve on more than six corporate boards, or to the election of directors who are CEOs of public companies and sit on more than three boards.
Moreover, the Credit Suisse findings may show a coincidence, rather than cause and effect. Credit Suisse didn’t crunch data showing, for example, how companies fared where directors were limited to serving on two boards.
There’s little arguing that the performance data is real, but there’s an obvious epistemic leap between observing that and concluding that interlock equals overboarding.
You’ll find below a list of stocks rated “outperform” by Credit Suisse whose directors only serve on one board. But first, a look at two key questions.
Overboarding and interlocking
The term “overboarding” is used to describe a situation where a director sits on many corporate boards and may not have enough time to do a good job for each.
Being a member of a board of directors “can be much more than a part-time job,” particularly if several companies require special attention simultaneously, said Kevin Petrasic, a banking partner in the Washington, D.C. office of White & Case LLP, and head of the Firm’s Global Financial Institutions Advisory practice, during a phone interview on Thursday.
According to a survey by the National Association of Corporate Directors, members of boards of publicly traded companies worked for an average of 278 hours per company on board-related business during 2014 — essentially the equivalent of seven 40-hour weeks — up 46% from 190 hours in 2005.
By contrast, interlocking refers to a company that has some board members also serving on the boards of other companies in related industries. They generally aren’t direct competitors — that could raise legal issues beyond the obvious potential for conflicts of interest.
This is because the Clayton Antitrust Act of 1914 “implicates antitrust violations if a director serves on the board of two or more competing companies,” according to Daniel R. Richey, an associate in the corporate department of Dinsmore & Shohl LLP in Cincinnati.
“Despite this, enforcement has not been robust, with an estimated one in eight directors serving on boards of ostensibly competing companies,” Richey said in an interview.
But Richey also said interlocked directors aren’t all bad. Interlocking boards can facilitate M&A activity, for example. That’s increasingly a central strategic focus of boards and investors, according to ISS.
“Board interlock can lead to a healthy transfer of market and regulatory intelligence between companies.” he said.
The Credit Suisse report
Citing data provided by MSCI, the Credit Suisse team said in a recent report that 39 companies among the S&P 500 SPX, -0.06% have a board full of directors that only serve on one board, down from 55 in 2013.
The Credit Suisse team calls sitting on more than one board “overboarding,” a far tougher standard than that of ISS. It maintains that if your directors are only directors of your company, they will have more time to focus on expanding sales and hopefully profit margins.
‘Overboarding’ is a negative for both corporate performance and investor returns.
“Since 2011, S&P 500 companies whose directors hold just one board seat have outperformed by a [compounded annual growth rate] of 43 [basis points],” said Dawson, the team’s leader.
This may not seem very significant, but it adds up over time. Achieving solid returns on equity and investment over a long period can also translate to very strong performance for a stock.
This chart from Credit Suisse shows the superior returns on equity over the past two years for S&P 500 companies whose directors only serve on one board:
Cash flow returns on investment have also been better over the past five years for the S&P 500 companies whose directors only serve on one board:
Credit Suisse covers 27 of the 39 S&P 500 companies whose directors only serve on one board and rates 11 of them “outperform:”
|Company||Ticker||Industry||Closing price – April 15||Credit Suisse price target||Implied 12-month upside potential|
|BB&T Corp.||BBT,+0.67%||Major Banks||$34.03||$42.00||19%|
|CF Industries Holdings Inc.||CF,+3.94%||Chemicals: Agricultural||$31.03||$40.00||22%|
|Chipotle Mexican Grill Inc.||CMG,-1.55%||Restaurants||$469.29||$550||15%|
|F5 Networks Inc.||FFIV,-1.09%||Computer Communications||$95.61||$110||13%|
|Gilead Sciences Inc.||GILD,+0.24%||Biotechnology||$98.29||$116||15%|
|Microchip Technology Inc.||MCHP,-0.87%||Semiconductors||$48.76||$52||6%|
|Nabors Industries Ltd.||NBR,+2.75%||Contract Drilling||$9.78||$10||2%|
|Quanta Services Inc.||PWR,+0.80%||Engineering and Construction||$22.60||$26||13%|
|Range Resources Corp.||RRC,+2.86%||Oil and Gas Production||$37.20||$38||2%|
|Vornado Realty Trust||VNO,+0.08%||Real Estate Investment Trusts||$95.96||$108||11%|
|Zions Bancorporation||ZION,+1.28%||Regional Banks||$25.54||$27||5%|
|Sources: Credit Suisse, FactSet|
More disagreement about Credit Suisse’s conclusions
“There’s little arguing that the performance data is real, but there’s an obvious epistemic leap between observing that and concluding that interlock equals overboarding,” according to Frank A. Mayer III, partner and chair of the Financial Services Regulatory & Enforcement Group, Dinsmore & Shohl LLP in Philadelphia.
Indeed, several outsiders maintain it can be good for directors to serve on more than one board.
“Having experience in other businesses could allow for better informed directors, with greater experiences preparing them to make decisions,” said Petrasic, the White & Case partner.
Ryan, of San Diego State’s Corporate Governance Institute, pointed out that the definition of overboarding used by the Credit Suisse researchers meant “the CEOs’ attention was focused solely on their own companies.”
Maybe that’s even more important than limiting the number of boards non-CEO directors serve on.
“Companies clearly believe that directors are not stretched too thin if they serve on two or three boards, and many appear to believe that directors actually benefit from serving on more than one,” she said.
She also pointed out that the average age for an S&P 500 director is 63. Retired executives “who serve on two or three boards now can invest much more time into them than those who served on just one in the past while working full time,” she said.
Whether or not you agree with the conclusions of the Credit Suisse analysts, their work is a reminder that it’s in your interest as an investor to read the biographies of everyone on your board of directors, and to consider whether there is anything that might impair their ability to work for you.