With an Outsider on the Board, Performance Markedly Improves

With an Outsider on the Board, Performance Markedly Improves


by Alessandro Minichilli and Daniela Montemerlo, Bocconi Department of Management and Technology
Translated by Alex Foti

In unlisted companies the benefits of structured rules and processes for corporate governance and openness to third-party board members tend to be underestimated, with risks of forestalling growth opportunity and either equity or non-equity partnerships, thus limiting potential performance in many small and not-so-small companies.

In all companies, the quality of human capital in governance is a sensitive issue. And it was precisely from actual people that we started in our research study at the SDA Bocconi Corporate Governance Lab. We tested the idea that an investment in this sense can help recover the accumulated delay on rules and processes, not to mention that potential partners by now consider the opening up of the company board a fundamental pre-requirement, so that it is much better to introduce them in boards that are already open.

To test the hypothesis we examined the profiles of 9,608 board members in 2,441 unlisted companies with turnover of more than €100M), who have no executive roles or links with ownership. The results seem to indicate that openness to outsiders has positive effects. Companies that introduce even just one external member increase net profitability by one point and operating profitability by 0.5 points just two years since entry (considering ROE and ROA adjusted by respective industry means). The effect is even more marked if the outsider joining the board has prior experience in listed companies (+1.5 adjusted net ROA), highlighting the transfer of good governance practices. Finally, the positive effect of outsiders in unlisted companies appears not to be an exclusively Italian phenomenon: similar data collected on a sample of unlisted companies in France, Germany and the UK, showed a 0.5 net increase in ROA for each 10% increase in outsiders. In addition, their presence seems to favor top-up replacement processes: +10% of outsiders equals +6% probability of successions, in turn, bearers of better performance (on average, adjusted ROE improves by +2.36 points and adjusted ROA by +0.86 points, counting with respect to the previous year and the one following replacement).

Yet family companies, equal to two thirds of the population surveyed, tend to have small corporate boards (4.6 on average), where just 24% of members are outsiders: this figure is likely to be an overestimate of the number of external members, because many are consultants with strong ties to the company’s owners. Shareholding coalitions of severa owners are better, since they tend to have larger boards (6 members) where 35% are outsiders. But the distance is still considerable compared to companies subject to financial markets, where outsiders are the majority (67%). To make the picture worse, it must be considered that, in family groups, there is a tendency to co-opt outsiders on boards of first- and especially second-level subsidiaries. So even if they are present, outsiders seem to play a non-central role.

Beyond cultural resistance from controlling shareholders, one wonders where there is an adequate supply of human capital in the market for board members. In this sense, the CG Lab provided a first, partial answer. Of the 9,608 board members analyzed, 5,551 were born in the same province where the company has its registered headquarters. This is not surprising if we consider the large presence of shareholders in corporate boards, as well as their historical consultants, which also allow for an opening up of governance that would not be possible with the direct inclusion of independents according to Borsa Italiana. But some important challenges remain, from excessive localism to the acquisition of new economic and financial skills, such as the legal and corporate side of M&A operations and risk management (which is often undervalued), as well as technological or digital transformations. Overcoming these challenges is essential to attain considerable value added, which is increasingly essential for corporate survival.

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