sealPurdue News

May 6, 2002

Outside directors improve U.K. CEO selection, stock returns

WEST LAFAYETTE, Ind. – The international trend toward more outside members on corporate boards of directors may make for better companies and higher shareholder returns, according to research studies by two Purdue University finance professors.

John J. McConnell

John J. McConnell, Emanuel T. Weiler Distinguished Professor of Management at the Krannert School of Management, and Jay Dahya, a Purdue University visiting professor of finance, studied the 1992 Cadbury Committee recommendations that boards of British corporations have at least three outside directors and different individuals in CEO and chairman positions.

While American corporate boards are composed largely of outside directors, firms elsewhere in the world have directors who are predominantly company insiders. The professors' research shows that worldwide board makeup is starting to change.

The first paper, "The Cadbury Committee, Corporate Performance and Top Management Turnover," was published in February by the Journal of Finance.

The researchers analyzed the relationship between CEO turnover and corporate performance to determine whether more outside corporate board members enhance board oversight.

"We found that companies that adopted the Cadbury recommendations were more likely to fire their CEOs when performance is poor and more likely to hire outside CEOs when the current CEO is dismissed," says McConnell, who teaches and conducts research in corporate finance.

The authors conclude that the recommendations of the Cadbury Committee have resulted in the U.K. in "a significant increase in board sizes, a significant increase in the number and fraction of outside board members, and a significant reduction in the number and fraction of firms with a single individual as CEO and chairman of the board."

McConnell says the research supports arguments that the Cadbury recommendations have improved the quality of board oversight in the United Kingdom.

But he and his co-authors add a caveat: "Increased management turnover and increased sensitivity of turnover to our measures of performance do not necessarily mean an improvement in corporate performance."

In "Outside Directors and Corporate Board Decisions: A Natural Experiment," McConnell and Dahya identify a worldwide trend toward American-style boards, where outsiders have come to play an increasingly important role.

McConnell and Dahya have investigated whether an increase in outside directors in British firms influences the boards' appointments of CEOs. Using a sample of 523 CEO appointments between 1989-99, they found "a significant positive correlation between the likelihood of an outside CEO appointment and the fraction of outside directors on the board."

McConnell says investors voted with their money for the outside CEOs as "the stock price reactions to the announcements of outside CEO appointments (0.79 percent) is significantly greater than the stock price reaction to announcements of inside CEO appointments (0.20 percent)."

The authors suggest that not only do outside board members make different decisions, but that those decision also may be better.

The researchers plan further investigations that include other countries to determine if outside directors do indeed make better decisions.

"At least 12 other countries (Australia, Belgium, Brazil, France, Greece, India, Korea, Malaysia, Mexico, South Africa, Sweden and Thailand) in the 1990s witnessed publication of Cadbury-style reports that recommend or mandate more outside directors," McConnell says.

Writer: J.M. Lillich, (765) 494-2077,

Sources: John J. McConnell, (765) 494-5910,

Jay Dahya, (765) 494-4393,

Purdue News Service: (765) 494-2096;


The Cadbury Committee, Corporate Performance
and Top Management Turnover

By Jay Dahya, John J. McConnell and Nickolaos G. Travlos

In 1992, the Cadbury Committee issued the Code of Best Practices which recommends that boards of UK corporations include at least three outside directors and that the positions of chairman and CEO be held by different individuals. The underlying presumption was that these recommendations would lead to improved board oversight. We empirically analyze the relationship between CEO turnover and corporate performance. CEO turnover increase following issuance of the Code; the negative relationship between CEO turnover and performance became stronger following the Code's issuance; and the increase in sensitivity of turnover to performance was concentrated among firms that adopted the Code.

Outside Directors and Board Decisions: A Natural Experiment

By Jay Dahya and John J. McConnell

During the 1990s, the global economy appears to have suffered an outbreak of "outsider director mania" – at least 18 countries have witnessed publication of guidelines that stipulate floors for the representation of outside directors on corporate boards. The apparent (largely untested) premise underlying this movement is that boards with significant outside directors will make different (and perhaps better) decisions than boards dominated by inside directors. As the first-mover in this movement, the U.K. provides a laboratory for a "natural experiment" to examine this presumption empirically. We investigate one key board task – the appointment of the CEO – to determine whether boards are more likely to appoint an outside CEO after they have increased the representation of outside directors to comply with the exogenously imposed standards. We find that the (coerced) increase in outside directors does alter the CEO selection decision. Additionally, announcement period stock returns indicate that the decisions are not only different, they also appear to be better.

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