Research Findings

Corporate elite fracturing and short-termism

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September 26, 2019

In 2014, CVS CEO Larry Merlo made the controversial decision to pull tobacco products from the store’s shelves. The decision immediately caused a 7% drop in stock price and cost the business $2 billion in revenues in the following year.

Yet, Merlo argued that this short-term sacrifice was necessary to promote CVS’s long-term competitiveness as the decision allowed the firm to position itself as a healthcare company, which would not be possible were the firm to continue selling tobacco products.

Carey and colleagues provide an account for how Merlo and the board of directors were able to promote and achieve a strategy that would cost shareholders in the short-term. First, Merlo had considerable discretion and autonomy as a CEO. Second, Merlo was able to convince the board to see the value of a long-term orientation, in part due to board members’ experiences on other boards facing similar decisions. Merlo and the board developed an approach, built on this understanding, for selling the firm’s strategy to investors and market analysts. The authors also document how other firms, including 3M and Verizon, made significant investments in R&D and innovation that paid off in the long run but at the expense of short-term gains.

As it turns out, the boards of directors at CVS, 3M, and Verizon were also among the most well-connected in corporate America. Corporate network relations have long been a subject of study for organizational sociologists. Traditionally, a well-connected board of directors was an important resource for a public corporation. Researchers have found that these networks provided exposure to governance and strategy ideas, a connection to the broader business community, and instilled norms of CEO autonomy and discretion.

Recently, however, business elites have become less likely to serve on the boards of multiple firms. Due to a confluence of factors, including the corporate accounting scandals of the late 1990s (Enron, WorldCom, etc.) and new corporate governance regulations (Sarbanes-Oxley, New York Stock Exchange listing requirements), firms increasingly eschew multi-board directors when selecting new members. Consequently, the typical corporate director today sits on fewer boards than two decades ago.

These changes have eroded a traditional platform for inter-organizational coordination and managerial autonomy. They also may have also damaged corporate elite cohesion, withering their sense of obligation and connection with multiple firms.

Our recent research suggests that the destruction of the corporate elite network has eroded a traditional resource that helped firms resist short-termism pressure. We analyzed board interlocks between 1998 and 2013, a period when the corporate elite network saw considerable structural fracturing, and their effects on three indicators of corporate time horizons.

First, we considered how board interlocks affected firms’ investments in research and development (R&D) because firms that cut R&D in response to earnings pressure frequently sacrifice long-term competitiveness for short-term earnings.

Second, we examined how firms manipulate their pension assumptions in order to decrease their pension expenditures and boost earnings.

Third, we considered how board cohesion affects shareholder rewards, which include both dividends and buybacks. Shareholder rewards allow investors to extract free cash flow that might otherwise be reinvested in the firm.

We calculated the extent to which firms sit in more or less structurally cohesive network communities, characterized by multiple overlapping and redundant network pathways. These cohesive network structures help generate norm enforcement and diffusion potential.

Our results showed that being positioned in cohesive board interlock communities was associated with increased R&D intensity, more modest pension assumptions, and reduced shareholder rewards. Moreover, network cohesion reduced firm’s propensity to cut R&D intensity or manipulate pension assumptions in response to missing financial analysts’ earnings targets.

Yet, as the board interlock network has lost its cohesion, the network effect no longer insulates firms from corporate myopia.

Taken together, our results suggest an under-appreciated and unintended consequence of the board networks’ fracturing. While shareholder advocates have argued that over-boarded directors are overworked and ineffective monitors, firms may benefit from directors’ information and socialization gleaned through multiple board appointments. These network resources are particularly helpful when boards must balance between short-term and long-term interests and incentives.

Our results show that the fracturing of the board network has had the unexpected consequence of withering a traditional platform for elite collective action that allowed boards to resist myopic pressures and maintain strategies for long-term value creation. While scholars and policymakers should consider alternative structures and institutions that can encourage long-term incentives and orientations, our evidence suggests that a traditional platform for corporate long-termism has eroded.

Read more

Richard A. Benton and J. Adam Cobb, “Eyes on the Horizon? Fragmented Elites and the Short-Term Focus of the American Corporation,” American Journal of Sociology 2019.

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