director interlocks and organizational similarity
TRANSCRIPT
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Director Interlocks and Organizational Similarity: an analysis of similarities in CEO
remuneration, corporate governance and sustainability reporting practices in Singapore
Yue Dong
Abstract: In this study, we are adopting a social network approach to study the effect of the
interlocking directorate network on the amount a firm pays its CEO, its adoption of good
corporate governance, as well as its initiatives on voluntary sustainability reporting. The explicit
decision I focus on is the level of remuneration packages CEOs receive in 461local SGX-listed
firms, the choice and type of firms corporate governance and sustainability reporting practices,
and how social interaction between firms board of directors influence the decision. We argue
that the CEO remuneration patterns, CG practices and SR initiatives of two firms will be more
similar if the two firms decision-makers belong to the same social network.
Keywords: Director Interlock, CEO Remuneration, Corporate Governance, Sustainability
Reporting
1. Introduction
Social Network Theory & Director Interlock
Social network theory dates back to the 1960s, when psychologist Stanley Milgram introduced a
famous six degress of sepreation (Dunbar, 2010). He showed that any two persons in the world
would be connected via six successive acquaintances. This theory has been tested and applied by
researchers in many areas such as business and management. Some researchers attempted to
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explain the continued existence of corporate interlocking by its practical functions (Ong, et al.,
2003). A social network perspective argues that managerial actions are embedded in social
structures (Granovetter, 1985). These social structures or networks, such as board appointment in
other firms, allow key decision-makers to share knowledge and eventually exert certain influence
on corporate decisions. (Gelekanycz and Hambrick, 1997; and Westphal et al., 2001). Sandell
(2002) argues that information about different social networks can supplement more
economically based explanations of organizational conducts, and social embeddedness is a factor
that has to be taken seriously at explaining the rationale for a firms conduct in a group of firms
belonging to the same system.
Those corporate conducts that have been studied include multidivisional organizational structure,
donations to nonprofit organizations, accounting decision to expense stock options, and adoption
of a poison pill approach to hostile corporate takeovers, etc (Davis and Greve, 1997; Kang and
Tan, 2008; Westphal et al., 2001). These researchers believe that organizational practices diffuse
within a director interlock because directors, through their multiple appointments in various
organizations, learn about the merits and appropriateness of different corporate practices and
develop preferences for certain practice. (Westphal et al., 2001).
Two firms are said to be connected by a director interlock when a person affiliated with one firm
sits on the corporate board of the other firm (Mizruchi,1996). Director interlock could take
several forms. For instance, Geletkanycz and Hambrick (1997) found that conformity of business
strategies across firms connected by director interlocks depends on whether these interlocks
depend on whether such interlocks are created by inside directors (executive directors) or outside
directors (non-executives). Also Phan, et, al. (2003) studied the prevalence of intra-industry
interlocks and inter-industry interlocks in Singapore, and found that intra-industry and regulatory
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agency interlocks accord more benefits to the individual director. Interlocks can also be created
through direct director interlocks or indirect director interlocks. Direct interlocks occur when two
individuals, A and B, from two different companies simultaneously sit on each others board.
Indirect interlock, on the other hand, occurs when A and B sit on the board of a third company, X.
The companies of A and B are said to have an indirect interlock though a third firm, X (Phan, et
al., 2003).
In this proposed study, we focus on the distinction between direct and indirect director interlocks.
Because direct interlocks of directors seem to suggest more communication channels and
potentially strong ties between directors, as compared to indirect interlocks, we posit that firms
connected by direct director interlocks are more likely to adopt similar organizational practices
than those formed only by indirect director interlocks.
Collectivism & Director Interlock in Singapore
Collectivism versus individualism is one of Hofstedes (1984) five dimensions of cultures. For
Hofstede, the collectivism individualism dimension refers to the extent to which a society is a
loosely knit social framework in which people primarily operate as individuals or in their
families instead of a tight network in which people primarily operate as in groups and out
groups. In Hofstedes survey, Singapore ranked low in individualism, suggesting a high
collectivism culture in the Asian emerging market. In fact, all Chinese-majority countries (i.e.
Taiwan, Hong Kong, and Singapore) score considerably lower on individualism than the
countries of the western world.
To date considerable empirical research on director interlock have been conducted in the
Western context, however there is a dearth of studies that have examined the extent and/or
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structure of interlocking directorate in Asian countries. Given the high level of collectivism in
the Asian countries, the importance of the role played by board interlocks should not be ignored.
To build on the previous studies on interlocks in Singapore, this paper investigates the extent to
which these interlocks have an influence on various corporate practices. The organizational
practices this paper focuses on are CEO remuneration,sustainability reportingand voluntary
corporate governance conduct.
CEO remuneration
The business press and the academic literature have debated the topic of increasing large chief
executive officer (CEO) salaries for many years, with a majority of writings calling CEO pay
unfair relative to the average worker. (Bebchuk and Fried, 2004; Fong, 2010). According to
executive compensation research firm Euilar, S&P 500 chief executives last year received
median pay packages of US$7.5 million. By comparison, official statistics show the average
private sector employee was paid just over $40,000. To address the public anger at the increasing
income disparity, a Dodd-Frank act will include a provision that requires U.S. companies to
disclose regularly the ratio of the median annual pay of all their employees to that of their chief
executive.
In the context of Singapore, the handsome remuneration packages paid to executive officers have
also been a touchy topic for the past few years. In 2009, CapitaLand's CEO Liew Mun Leong
earned a record $20 million bonus, which received much local media attention and public anger.
Given Singapores ever-increasing importance as a global financial hub, coupled with the fact
that its corporate policies closely follow the trends in the U.S. and U.K., similar regulatory
changes in Singapore is very likely.
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So far most studies on CEO remuneration has been from the economic perspectives, and the best
documented empirical finding in the CEO compensation literature is the consistency of the
relation between CEO pay and company size. Since 1990s, corporate governance practices have
received increased attention and all publicly listed firms (in Singapore) are required to set up
remuneration committee (RC) to design firm-specific executive compensation strategies that
align with corporate strategy. As RCs are made up of board of directors of the firms, we draw on
earlier work that explored social influence among board of directors to assess how director
interlocks can lead to similarity in CEO remuneration. One similar study by Sandell (2002),
whose research focus was chairperson remuneration, found that firms with director interlocks
showed a significant tendency to compensate chairpersons at a similar level, while the effect of
regional and industrial proximity is negligible. Based on the above, together with social
network theory, we form the following hypotheses:
H1a: Firms with direct director interlocks are more likely to compensate their CEOs
similarly than firms without director interlocks.
H1b: Firms with indirect director interlocks are more likely to compensate their CEOs
similarly than firms without director interlocks.
H1c: Firms with direct director interlocks show stronger similarity in their CEO
remunerations than firms with indirect director interlocks.
Corporate Governance
Being one of the leading financial hubs, Singapores corporate governance system evolves along
the lines similar to those of the U.S. and U.K. (Jensen and Ruback, 1983). In the post Asian crisis
era, corporate governance evolved rapidly towards the standards promulgated by the
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Organization for Economic cooperation and Development (OECD) in 2000 (Phan and
Yoshikawa, 2003). Both Singaporean regulatory authorities and business corporations are facing
increasing pressure and challenges to practice and promote good corporate governance.
Currently companies listed on Singapore Stock Exchange are governed under The Code of
Corporate Governance 2005, but strict compliance with the Code is not mandatory. Companies
may choose not to follow the Code requirement, with explanations have to be provided. Given
the non-mandatory nature of the requirements under the Singapore Code, it seems reasonable to
expect, besides the standard economic cost-benefit consideration, social influence among
directors could also influence a firms decision to meet these requirements. Based on a sample of
295 listed companies in Singapore, Ong, et al. (2003) found firm size, board size, total assets,
and some other economic/financial variables significantly correlate with board interlocks. Here
we are interested in exploring the link between companies choice to meet these CG
requirements, a non-economic variable, and director interlock, which leads to the following
hypothesis:
H2a: Firms that have direct director interlock with other firms that adopt corporate
governance practices are likely to adopt similar practices.
H2b: Firms that have indirect director interlock with other firms that adopt corporate
governance practices are likely to adopt similar practices.
H2c: Firms that have direct director interlock are more likely to adopt similar corporate
governance practices than firms with indirect director interlocks.
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Sustainability Reporting
During the last decade, Sustainability Reporting (SR) has been increasingly adopted by
corporations worldwide. (Lozano & Huisingh, 2010). Sometimes also labeled Corporate Social
Responsibility (CSR) reporting, sustainability reporting fulfills a role in showing how
companies account for their CSR, a concept that is seen to embody companies economic, legal,
ethical and philanthropic responsibilities towards society in general and their range of
stakeholders in particular (Carroll, 1999; Whetten et al., 2002). A companys sustainability
initiatives are usually reported as part of the companys annual reports. In its simplest form, the
sustainability report or SR spells out a companys non-financial initiatives and activities.
Growing concerns and interests in environmental protection and social responsibility worldwide
are driving investors and other stakeholders to look beyond companies standard financial
reporting to how they are managing their environmental and social impact in the conduct of their
business (Sadashiv, 2010).
In the past, companies mostly followed their own reporting styles. Although sustainability
reporting is not yet made mandatory in Singapore, the Singapore Exchange (SGX) has always
been encouraging companies to consider the adoption of SR. It has recently proposed through a
policy statement that listed companies adopt sustainability reporting as part of their corporate
disclosures (Sadashiv, 2010). Leaders and staff are increasingly recognizing their role and
responsibilities and consequently, are engaging in voluntary actions to contribute to
sustainability. Since board members are known to be eligible to sit on more than one board, it is
reasonable to expect that board interlocks between firms provide valuable information about the
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costs and benefits of sustainability reporting, thus influencing firms SR choices. Based on the
above, we hypothesize that
H3a: Firms that have direct director interlock with other firms that adopt sustainability
reporting are likely to adopt similar practices.
H3b: Firms that have indirect director interlock with other firms that adopt sustainability
reporting practices are likely to adopt similar practices.
H3c: Firms that have direct director interlock are more likely to adopt similar
sustainability reporting practices than firms with indirect director interlocks.
Figure 1 summarizes the above hypotheses into a conceptual diagram.
Contribution
This study seeks to contribute to existing literature about by highlighting the network effects on
organizational decisions among publicly traded firms in Singapore. The three aspects on which
we examine the social network effects are not chosen coincidentally. CEO remuneration,
corporate governance and sustainability reporting have raised much controversy and sparked
considerable academic interest in both local and global financial regime.
To date, numerous empirical work on interlocking directorates has been conducted in the United
States and to a lesser extent in Canada, Europe, and Australia. (Ong, et al. 2003). Only a handful
of such studies are carried out in local context, despite the fact that collectivism is more
prevalent in Asian countries, with the influence of interlocking directorate is expected to be
stronger than that in Western countries. This study will fill the literature gap here.
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Following the collapse of Lehman Brothers and global financial crisis, changes to the corporate
governance landscape are looming on the horizon (Chan, 2010). Sustainability reporting, which
has also drawn growing investor attention in Singapore, is being reviewed extensively by
relevant local authorities. While many countries are setting up guidelines on the mandated
reporting of sustainability disclosures, Singapore may eventually make many corporate
governance requirements and SR mandatory for local listed companies as well. This study is
important because currently local regulatory bodies are still facing much resistance and
reluctance from firms with regard to certain corporate governance requirement changes.
Knowing the importance of social embeddedness in corporate conducts, regulators could focus
their efforts on increasing awareness in those directors who have appointments in multiple firms.
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Figure 1. Conceptual Diagram
H3bH2b
H1bH2a
Direct
Director
Interlock
Indirect
Director
Interlock
CEO
Remuneration
Voluntary
Corporate
Governance
Initiatives
Voluntary
Sustainability
Reporting
Internal AuditFunction
Existence ofIndependent
Financial Expert
Fulland DetailedDisclosure of
Executive
Remuneration
3 Types ofSR:
SeparateSustainability
Financial Repowith Integrate
Sustainability
Website DisclofSustainabil
Initiatives
Fixed Component Variable Component Total Remuneration
H1a
H3a
H1c: H1a > H1b H2c: H2a > H2b H3c: H3a > H3b
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2. Methods
2.1 Selection of Sample
A list of listed companies on the Singapore Stock Exchage (SGX) mainboard is to be obtained.
Companies listed on the mainboard have at least a five-year history of stable operations.
Therefore their corporate governances are more stable, which means that board interlocks would
have been formed. (Phan, et. al 2003). By January 2010, there were 774 listed companies. We
exclude 313foreign listings. Each of the remaining 461 companies is treated as a separate entity.
Annual reports of all firms listed under SGX are downloadable from SGX websites.
From each companys 2009 annual report, the following information will be extracted:
(1) Names of directors(2) Industry classification(3) Company accounting data, namely Return on Equity (ROE), Market Capitalization,
Value of Total Assets
(4) CEOs remuneration classification, level and mix of remuneration(5) CEOs age and number of years with the same company(6) Percentage of stock holdings of each of the top 20 shareholders(7) Whether or not an Internal Audit Function is established within the firm(8) Whether or not there is an Independent Financial Expert in the board(9) Whether or not there is full and detailed disclosure of CEO remuneration(10) Whether or not the firm issues a separate sustainability report(11) Whether or not the firm issues financial reports with integrated SR info(12) Whether or not there is website disclosure of sustainability initiatives
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2.2 Design and Procedure
Matched Pair Design
Interlocking Pairs - Pairs of firms with interlocking directorate are to be identified and extracted.
For the purpose of this study, listed subsidiaries of other listed parent companies are to be
excluded from interlocking pairs. However, they could be used as control firms (see below). We
define Direct interlocks as the number of individuals who sat simultaneously on the boards of
firms i and j. Indirect interlocks was the number of times in which board members from firms i
and j sat together on the boards of firms k, i.e. indirect interlocks exist between firm i and j.
Control Pairs - For each of firms identified in the interlocking pairs, it will be matched by
another firm (not in the interlocking samples) by size and industry.
Inter-rater Reliability
Given the complexity of this study, two raters will analyze the financial statements and use an
excel spreadsheet to store their codings. Both of them will conduct analyses and prepare codings
on the 50 same sets of financial statements in the beginning. Following which an inter-rater
reliability test (Cohen's kappa) will be carried out. If satisfactory agreement between the two
raters is achieved (say, Cohens kappa greater than 0.75), each of them will be working on
different sets of statements for the remaining samples.
Measures - CEO Remuneration
1)Dependent Variables
Following the same methods by Sandell (2002) and Mizruchi (2002), we operationalize
similarity between two firms CEO remunerations as:
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Sij= -1*|(i-j |
Where Sij equals similarity in CEO remunerations between firms i and j; and iand j equal the
amount of remuneration received by the CEO from firm i and j, respectively. The absolute
difference in CEO remuneration is multiplied by negative one to transform it into a similarity
score. In this way, a high level of similarity could correspond to high values of Sij.
In a typical annual report of a SGX-listed firm, directors remuneration is usually broken down
into the components: Salary and Directors fees, Bonuses, Stock Options and Others. The
Others include remuneration components, for instance retirement benefits, which cannot be
grouped under other categories. CEOFIX represents the fixed component (Salary, Directors
Fees, etc) of the remuneration package. CEOVAR represents the variable component (Stock
Options, Bonuses, etc.) of the remuneration package. CEOTOT represents the total amount of
the remuneration a firms CEO receives. In this study we do not study the others component
for two reasons. First, companies usually do not disclose the exact amount and/or type of
payment to executives allocated under this category. The second reason is the weights of others
component are usually negligible (
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percentage of equity held by each individual shareholder. To account for the effects of human
capital factors, I use the age of the CEO (CEOAge) and number of years spent on the board of
the current firm (CEOYr) as a measure for CEO experience.
Similar to the case of independent measure, I transform all of these independent measures of two
firms specific characteristics into a joint measure of similarity by using the procedure above.
3)Independent Variablie (Relational Measures)
Two relational measures, director interlock and competitive relationship, are used in the study.
As mentioned above, Direct interlocks (DirInt) as the number ofindividuals who sat
simultaneously on the boards of firms i and j. Indirect interlocks (IndInt) was the number of
times in which board members from firms i and j sat together on the boards of firms k, i.e.
indirect interlocks exist between firm i and j.
A dummy variable is created to measure the competitive relationship between two firms. The
dummy variable is coded as 1 (one) if two organizations operate in the same industry, and 0
(zero) otherwise.
Measures - Corporate Governance (CG)
Measures of CG practices are: internal audit function, independent financial expert, and full and
detailed disclosure of executive remunerations. These are the commonly used and easily
measurable indicators for CG. Also, for the purpose of this study, these are some of the
important practices recommended under Singapore Corporate Governance Code (2005). IntAud
is coded as one if a firm has such function in practice, coded as zero otherwise. Similarly coding
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applies to IndFin and FulDisc, which represent the existence of an independence financial expert
on the firms board and full disclosure of executive remunerations, respectively.
Measures - Sustainability Reporting (SR)
We measure SR initiatives in terms of the three types of disclosure. SepSR is coded as one if a
firm prepared a separate sustainability report for the financial year2009/2010, coded as zero
otherwise. FIntSR represent financial reports with integrated sustainability information and
WebSR refers to the website disclosure of sustainability initiatives. Codings for FIntSR and
WebSR are the same as coding for SepSR.
3. Analyses
Descriptive Statistics
The mean, standard deviation and correlations among the similarity variables will be presented.
Comparisons of the CG and SR practices among direct interlocking pairs, indirect interlocking
pairs and control pairs will be shown in tables, with relevant histograms. Industry classifications
for the interlocking firms and control firms will be tabulated as well.
CEO Remuneration
The random effect model regression below is used:
Sij = + ij+ij+i+ij
Where Sij is the similarity in the CEO remuneration as defined above, ij is the k variables
describing the relationships between firms i and j, ijis the k measures of simililarities in firm
specific characteristics, and are regression coefficients, i is the unit-specific residual. It
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differs between is, but for any particular i, its value is constant. ij is the ordinary residual with
the usual properties.
The model is to be run on both interlocking and control pairs. Coefficients andon the
regression ofpairs are to be compared, with p values to be analyzed. From these coefficients we
could examine the similarities in various firm-specific characteristics among interlocking firms.
The Sij in CEO remuneration will be compared between interlocking and control pairs to the
testing of hypotheses 1a and 1b. Results for direct interlocking firms and indirect interlocking
firms will be compared for the testing of hypothesis 1c.
Corporate Governance (CG) & Sustainability Reporting (SR)
The number of times the same practices are observed between pairs is to be compared between 1)
direct interlocking firms and control firms; 2) indirect interlocking firms and control firms; and 3)
direct interlocking firms and indirect interlocking firms. Chi-square test is appropriate for the
testing of any statistical significance.
4. Discussion
In this study, we seek to identify if director interlocks among Singaporean firms play a part in
firms decisions. Using a matched-pair design, we create pairs of firms which are interlocked
by common board of directors and select another pair of firms that match the interlocking pair by
size and industry as control pair. To test the effect of interlocking directorate on CEO
remuneration, we adopt a random effect regression model. To test the effect of interlock on CG
and SR practices, chi-square test is used. With several similar research done previously
(Mizruchi & Sterns, 2002; Sandel 2002), Results are expected to be significant for CEO
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remuneration (H1a, b & c) in our study. Tests for direct director interlocks are expected to show
stronger significance as compared to indirect interlocks.
The limitations of the proposed study are as follows:
1. Sample size is a key issue in this study. With four companies are needed in each set of pairs, a
total number of 461 companies could only render a maximum of 115 valid sets of samples.
2. Double interlocks may exist for firms, i.e. both direct and indirect interlocks may exist for
some pairs of firms. For the purpose of the study we do not account for the double interlocks. In
the case of double interlocks only direct interlock is recorded, since direct interlock is expected
to be more significant than indirect interlocks. Therefore bias may exists.
With the results from this study, we wish to bring local regulators attention to the significance
of interlocking phenomenon in Singapore. The regulators, such as Singapore Stock Exchange
(SGX) and Securities Investors Association Singapore (SIAS), could consider focusing their
educational campaign on not only individual managers, but also directors who hold appointments
in multiple firms.
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