Director independence – “Balanced boards outperform”

GLC research considers the relationship between board independence and stock price performance.

In October 2016 the Governance Leadership Centre published commissioned research exploring the relationship between board independence and stock price performance. The GLC commissioned the research, undertaken by Professor Alex Frino (Professor of Economics and Deputy Vice Chancellor (Global Strategy) University of Wollongong), as a contribution to the debate about board composition and performance.

Professor Frino’s research found that:

• Balanced boards, that is, those with between 30% and 60% of independent directors, outperform others, with evidence strongest in the 40% to 60% category; and
• There is a non-linear relationship between stock returns and board independence.

This important study found that within ASX 200 companies, those with balanced boards (between independent and non-independent directors) outperformed others in terms of market-adjusted stock price returns.

The research identifies a “sweet spot” - where independent directors comprise between 40% and 60% of the total board – showing the strongest statistical result for out-performance.

The paper, ‘The relationship between board independence and stock price performance’ is based on a review of ASX 200 companies between 2004 and 2012. The time-consuming study took over a year to complete.

The results of this research confirm that representation by independent directors can improve company performance measured in terms of stock returns – to a point. Companies which have “balanced” boards outperform those with both little or no independent directors and those with little or no non-independent directors.

Asked to summarise the key take-outs from the research, Professor Frino said: “Quite simply, that balanced boards are best. Having independent directors on boards adds value, as does having non-independent directors who may be former executives or who hold substantial shareholdings. Getting the mix right is what matters.”

The Governance Leadership Centre commissioned this research to contribute to a more robust framework for debate on the value offered by independent directors.

It is widely accepted that independent directors play an important role in achieving good governance. While the definition of “independence” varies, it features in almost all global governance standards, from the Organisation for Economic Co-operation and Development (OECD) to every major stock exchange, including the ASX Corporate Governance Council. The AICD also promotes the contribution of independent directors to effective governance.

Australian empirical research on the link between independence and performance, however, remains relatively limited, and other academic studies have produced conflicting results.