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Corporate Governance and Firm Diversification
Financial Management (Financial Management Association), Spring, 2000 by Ronald C. Anderson, Thomas W. Bates, John M. Bizjak, Michael L. Lemmon
The multivariate analysis on outside blockholdings (Model 3) is similar to our earlier univariate results and to Denis et al. (1997). Although the coefficient on the multi-segment dummy is statistically significant at the 0.10 level, it is economically small. The magnitude of the regression coefficient indicates that, on average, outside block holders own 0.5% fewer shares in multi-segment firms relative to their holdings in single-segment firms. This finding suggests that the monitoring incentives of large shareholders are not attenuated in diversified companies and is inconsistent with an agency explanation for diversification.
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The table also illustrates the relation between diversification and the composition of the board of directors. Model 4 indicates that the boards of diversified firms tend to be larger than those found in single-segment companies, although this difference is small (approximately 0.31 directors). If, as suggested by Yermack (1996), larger boards are less effective monitors, finding larger boards in diversified firms is consistent with an agency motive for diversification. The small differences in board sizes do not support this argument. Models 5 and 6, however, also document a substitution of outside for inside members on the boards of multi-segment companies, where multi-segment firms have on average 5% (p-value = 0.00) more outside directors than single-segment firms. Brickley, Coles, and Terry (1994), Byrd and Hickman (1992), and Hermalin and Weisbach (1988) suggest that outside directors provide an important monitoring function on corporate boards. [9] Thus, a higher fraction of outsiders on the boards of diversified firms suggests that these firms are increasingly dependent upon board monitoring to reduce the potential agency conflicts that arise because of low managerial ownership and less performance sensitive pay.
In summary, our analysis indicates that CEOs in diversified firms have pay that is less sensitive to firm performance and lower fractional equity ownership compared to CEOs of single-segment firms. We find, however, that compared to focused firms, diversified companies have boards of similar size, but with more outside directors. The ownership of outside block holders is also similar. Finally, the relation between managerial turnover and firm performance is not significantly different between the focused and diversified companies. These findings suggest that alternative governance mechanisms may be used as substitutes for reduced CEO stock ownership and lower pay-for-performance sensitivities in diversified firms.
V. Governance Structure and the Decision to Change Focus
If agency problems are responsible for managers engaging in and maintaining value decreasing diversification strategies, then we would expect to find that increases in diversification are associated with lower CEO ownership, fewer outside directors, lower holdings by outside blockholders, and less reliance on equity-based compensation. To investigate this hypothesis, we use the longitudinal nature of our data set to analyze the relation between governance structure and changes in firm focus.
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