The Wall Street Journal reported this week that institutional investors are starting to take a stand against overboarding. What is overboarding? It is the practice of sitting on too many boards at once. It’s understandable that members would want to do this: Board membership can be easy money and low-commitment prestige. But it’s surprising that shareholders have put up with it for this long.
When we first launched Vident's domestic equity indices (first VIUSX and now VCUSX) several years ago we identified overboarding as a crucial risk factor affecting investors. Board membership is the sort of thing which requires a lot of self-imposed diligence. It's not hard to go with the flow, drop levels of vigilance, and take management's word for granted on the big decisions. Testing, questioning, and dissenting require self-discipline and putting in more prep time than the bare minimum needed to keep the gig -- someone who sits on many boards at the same time may find all that extra work hard to get to. And top management is not exactly incentivized to remove under-prepared, docile board members.
In addition, there is some risk that members who serve on many boards may have turned board membership into a primary source of income. Such members are less likely to rock the boat for fear of losing a key income stream.
Blackrock and other firms have been increasingly voting against the reelection of board members who have too many board-level commitments in place. This is not just a matter of corporate civic responsibility, there's prima facie evidence of investor impact. According to the Wall Street Journal:
"A new analysis of S&P 500 chief executives for The Wall Street Journal by Equilar, a research firm, suggests that leaders with multiple outside corporate board seats and their employers make more money, but their shareholders see lower returns than those with one or zero outside directorships."
That's a fascinating finding: Not just that overboarded corporations underperform for investors, but that they overperform for corporate executives in terms of delivering high salaries. This is suggestive of a pattern in which boards are 'captured' by the managers who they are supposed to be overseeing. Boards which are de facto satrapies for top management tend to grant greater compensation. Heck, that's how they stay in place.
Also interesting is the pattern in which higher reported earnings from overboarded firms coincide with lower investment performance. The companies are making more money, but the shareholders are making less. This means that these shareholders are receiving a smaller share of reported earnings from these firms than shareholders from other firms. That's either because these companies are actually making less than they report, or boards are sharing less of what they make. Maybe both: Bad governance practices and misleading financial statements tend to go together.