Undervaluation of directors in the board hierarchy: Impact on turnover of directors (and CEOs) in newly public firms

Abstract

Research summary: We examine the consequences of the formalization of the board leadership structure at IPO for board‐level turnover. We introduce the concept of director undervaluation. It indicates the degree to which a director’s qualifications based on normatively accepted criteria for board leadership are not duly reflected in his/her appointments to the board chair and committee chair positions. We find that the higher the average undervaluation of directors on the board (“board undervaluation”), the greater the turnover levels of undervalued directors. This effect is stronger when board interaction frequency is higher. We contribute to the behavioral perspective on corporate governance by introducing justice‐based legitimacy as a key normative institution, and by providing a novel predictor of aggregate turnover of directors (as well as the firm’s CEO). Managerial summary: Why do outside directors exit the board? We offer a novel answer to this question in the context of newly public firms. We suggest that when directors are passed over for the board chair and committee chair positions despite having higher qualifications than their peers, they have been “undervalued,” and a negative board climate is likely to develop. We find that the higher the average undervaluation of directors on the board, the higher the turnover levels of these undervalued directors. More frequent board meetings exacerbate these turnover levels. Further, these turnover effects are not restricted to undervalued directors—even the CEO is more likely to exit. This study demonstrates the critical importance of developing a legitimate and fair board leadership structure.

The role of the board chair—A literature review and suggestions for future research

“…Moreover, one study found that appointing a board chair who was not previously appointed to this role-despite having higher qualifications than other directors-might lead firms to experience a higher rate of director turnover, followed by the recruitment of less qualified new board members (Garg et al, 2019). To curb a high director turnover and the development of a negative board climate, board members may be more vigilant in their evaluation and monitoring roles (Garg, Li, & Shaw, 2018). (Aktas et al, 2019;Kim et al, 2009; cf.…”

Social Relationships and Turnover: A Multidisciplinary Review and Integration

“…This limited mobility as employees had fewer external contacts and thus less information about external career opportunities. Garg, Li, and Shaw (2018) found that the frequency of social interactions among board members increased the likelihood of turnover for those directors who were under-evaluated (i.e., not appointed as a board chair or a committee chair despite their qualifications). Garg et al argued that as social interactions among board members increase, such interactions remind under-evaluated directors of the unjustified assessment, increasing rumination about the injustice and leaving behavior.…”

Family Versus Institutional Involvement in Restructuring: Evidence From the Communications Equipment Industry

“…The sample includes data for each firm beginning with the first year as a publicly traded firm. Following Garg et al (2018), IPO year is coded as 1 if a firm went public in a given year and 0 otherwise. This control captures the potential vulnerability of firm performance to its newly public status.…”