Board Vigilance, Director Experience, and Corporate Outcomes

Strategic Management Journal
Strat. Mgmt. J., 29: 363382 (2008) Published online in Wiley InterScience (www.interscience.wiley.com) DOI: 10.1002/smj.649 Received 1 March 2005; Final revision received 25 July 2007
BOARD VIGILANCE, DIRECTOR EXPERIENCE, AND CORPORATE OUTCOMES

MARK KROLL,1 BRUCE A. WALTERS,1 * and PETER WRIGHT2
1 College of Administration and Business, Louisiana Tech University, Ruston, Louisiana, U.S.A. 2 Fogelman College of Business and Economics, University of Memphis, Memphis, Tennessee, U.S.A.
Agency-based studies of boards of directors address factors relevant to board vigilance with respect to the monitoring of senior managers. We argue that relying solely on director vigilance may be limiting because vigilance without relevant experience is unlikely to ensure board effectiveness. Our contention is that boards comprising vigilant directors, as well as directors with appropriate knowledge gained through experience, not only will be better monitors, but also more useful advisors to top managers. The focus of our study is on the effect on acquisition outcomes of the interaction of board vigilance and director experiential learning. Consistent with our expectations, the empirical ndings indicate that vigilant boards rich in appropriate experience are associated with superior acquisition outcomes. Copyright 2008 John Wiley & Sons, Ltd.
INTRODUCTION
Corporate acquisitions constitute a major economic activity. With acquisitions totaling nearly U.S. $1.95 trillion annually (Hahn, 2005), they have naturally been the object of considerable attention in both the popular and academic press. In the academic domain, mergers have frequently been examined from the perspective of agency theory (e.g., Amihud and Lev, 1981; Shleifer and Vishny, 1991; Wright, Kroll, Lado, and Van Ness, 2002). A key motivation for much of the agency-oriented research is the frequent disconnect between managers enthusiasm for pursuing acquisitions as a
Keywords: corporate governance; boards of directors; acquisitions
*Correspondence to: Bruce A. Walters, College of Administration and Business, Department of Management and Information Systems, Louisiana Tech University, PO Box 10318, Ruston, LA 71272, U.S.A. E-mail: bwalters@cab.latech.edu
corporate growth strategy and the prevalence of acquisitions that deliver mixed shareholder returns, some positive and others negative (Agrawal, Jaffe, and Mandelker, 1992; Andrade, Mitchell, and Stafford, 2001; Asquith, 1983; Asquith and Kim, 1982; Jarrell and Poulsen, 1989; Jensen, 1986; Kroll et al., 1997). Given the dispersion in ndings reported by agency-based studies of acquisition performance, there are obviously other factors that inuence the relationship between mergers and associated outcomes. Based on meta-analyses, King et al. (2004) concluded that acquisition performance variance is likely due to variables yet to be identied. Contemporaneously, management scholars have come to recognize the need for a more eclectic examination of the role that boards of directors play in inuencing corporate acquisition performance (Daily, Dalton, and Cannella, 2003). Clearly, relying solely on agency theory-related
Copyright 2008 John Wiley & Sons, Ltd.
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M. Kroll, B. A. Walters, and P. Wright

of the study. Finally, we present our discussion and ideas for future research.
measures of boards compositions and characteristics, such as the number of insiders vs. independent outsiders, blockholder board membership, or board member ownership, among others, is unlikely to further advance our knowledge in explaining boards effectiveness in corporate decision making and control. More independent outside directors, blockholder board membership, and board member ownership indicate that directors are vigilant as monitors; but while vigilance per se may be necessary, it may not be a sufcient condition for director effectiveness. Carpenter and Westphal (2001) suggest that governance research could be advanced by going beyond an emphasis on the boards propensity to engage in decision control to consider whether directors have the relevant experience to enable them to exercise control and advise management effectively. We likewise believe the possession of suitable knowledge learned via director experience may be important in explaining board effectiveness. Axiomatically, regardless of the level of vigilance, boards with directors who lack relevant experience are probably incapable of fully contributing to corporate strategy. Consequently, in addition to agency concerns for director vigilance, the simultaneous consideration of director experience may afford opportunities for greater understanding of the linkage between boards of directors and rm outcomes, such as acquisition performance. In our study, we anticipate that directors act not only as monitors of managerial decisions, but also as providers of advice to senior executives. Our anticipation is in agreement with the proposals of others who have argued that board members provide both oversight and counsel (Demb and Neubauer, 1992; Lorsch and MacIver, 1989; Westphal, 1999). More specically, we expect that directors are involved in controlling and consulting as managers consider corporate acquisition strategies. This expectation is also in conformance with the observation that boards are virtually certain to be involved in takeover attempts; in fact, legal commentaries state that reviewing acquisition proposals put forth by management is a duty of the board (Byrd and Hickman, 1992: 196). The remainder of this study is organized into several sections. In the following section, we review the literature and offer our hypotheses. Subsequently, we describe the sample construction and research methodology. We then report the results
LITERATURE REVIEW AND DEVELOPMENT OF HYPOTHESES

According to agency theory, the performance impact of boards depends on directors independence and inducements to monitor managerial decision making (Baysinger and Butler, 1985; Booth and Deli, 1996; Mallette and Fowler, 1992). In this vein, agency theory has provided much in the way of explanation concerning vigilant boards (Fama, 1980; Finkelstein and Mooney, 2003; Ryan and Wiggins, 2004). Extant agency-based research suggests that the presence of independent outside directors may result in improved performance (Wright, Kroll, and Elenkov, 2002). Moreover, rms with board members who are blockholders (holders of at least 5% of a rms outstanding shares) are found to experience positive market responses to acquisition announcements (Kroll et al., 1997). Also, equity stakes are documented to help align outside board members interests with those of shareholders, ensuring active oversight of management and acquisition strategy (Hambrick and Jackson, 2000; Jensen, 1993). Thus, various studies have informed us regarding the benets of board vigilance resulting from the presence of certain directors. Particularly when contemplating an acquisition, a board may be especially well served by having independent outside board members, blockholders as directors, and directors who hold common stock, given that acquisitions represent major strategic decisions potentially affecting shareholders far into the future. As noted, however, we argue that a sole reliance on agency theory when considering a board of directors results in an underspecied explanation of director effectiveness. Although agency theorys prescription for desirable directors on the board addresses factors relevant to vigilance, this theory does not elaborate on issues pertaining to directors experience as it impacts strategic decisions. We contend that director experience in the target industry and in making acquisitions facilitates learning and the development of knowledge useful in making protable acquisitions. Consequently, boards comprising experienced directors should be in a superior position to monitor and advise the management of acquiring enterprises.
Strat. Mgmt. J., 29: 363382 (2008) DOI: 10.1002/smj
Board Vigilance, Director Experience, and Corporate Outcomes

We emphasize that agency theory is silent on the role that knowledge gained through experience plays with regard to board participation in rm strategy. Theoretically, learning takes place by doing (Nelson and Winter, 1982) and performance feedback on what is done (Greve, 2003). Experience with doing and feedback on what is done can be expected to improve future related behaviors qualitatively because of learned knowledge. As individuals learn or accumulate knowledge via experience, they may feel enabled and become further engaged in making contributions toward corporate competitive advantage (March, 1999). This implies that experienced directors, feeling enabled, might further involve themselves in the promotion of rm advantage. Nevertheless, we shall remember that select behavioral research on directors concludes that managerial manipulation can lessen board involvement in the detail of corporate strategy (e.g., Boeker and Goodstein, 1993; Finkelstein and Hambrick, 1996). Our conjecture, however, is that directors may be uninvolved with specicities of strategy not necessarily because of executive manipulation, but rather to the extent that they lack knowledge because of an absence of relevant experience needed to inuence a particular strategy. Lacking the appropriate expertise, directors may be constrained intellectually from becoming thoroughly involved. In contrast, with experience, directors might become engaged in monitoring and advising because, through experiential learning, they may be enabled to contribute positively to rm outcomes. Our contentions are likewise compatible with the premise put forth that individuals may be enabled to participate actively and effectively by the knowledge developed through personal experiences (Kiesler and Sproull, 1982; Walsh, 1995), such as experiences with corporate acquisitions. Personal experiences can also boost the understanding of context (Porac, Thomas, and BadenFuller, 1989) and ones thought process related to the context (Huff, 1990). Thus, via experience, directors not only may develop a better understanding of acquisitions, but also the relationship of such strategies to a special context or a particular target companys industry (Reger and Huff, 1993). Moreover, some researchers suggest that persons endowed with experience in related arenas, rather than diffused across various spheres, have more densely developed knowledge structures for those arenas (Day and Lord, 1992). Consequently,
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given the presence of relevant knowledge, monitoring and advising may be facilitated (Lorsch and MacIver, 1989), as board members could rely on lessons learned in prior related experiences (Dearborn and Simon, 1958). Indeed, the learning process through experience may be more heavily relied upon than secondary sources, possibly because of personal involvement or recency (Kahneman, Slovic, and Tversky, 1982). Our anticipation throughout the study is that a boards vigilance can be exercised more effectively vis-` -vis management if the board also has direca tors with relevant experience. In effect, decisions of individuals are anticipated to be inuenced by the knowledge gained from their set of past experiences (Beckman, 2006; Burton, Sorensen, and Beckman, 2002). Moreover, directors are expected to bring accumulated knowledge with them as they move across enterprise boundaries. This expectation is compatible with the argument that a persons prior career experiences shape the range of decisions he or she will consider in the execution of subsequent career responsibilities (Baty, Evan, and Rothermel, 1971; Boeker, 1997; Sorensen, 1999). At the board of directors level, the shaped range of decisions serves as a model of what the organization should consider strategically. Therefore, we propose that the interaction of director experience with agency theorys factors related to vigilance may provide a richer perspective on the effectiveness of boards as they impact acquisition outcomes. In the succeeding paragraphs, the interactions of each of the aforementioned agency factorsindependent outside directors, blockholder board membership, and board member ownershipwill be discussed in terms of director experience, culminating in our proposed hypotheses. Interaction of independent outside directors and experience Agency theory recognizes that conicts of interest are inherent in all contractual arrangements involving principals and agents (Gibbs, 1993; Jones and Butler, 1992). The presence of outside board members may reduce these conicts of interests. Some outsiders, however, are beholden to the CEO because of business relationships (e.g., lucrative consulting contracts) (Finkelstein and Mooney, 2003; Johnson, Daily, and Ellstrand, 1996). Board members who work for nancial services rms,
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attention on the most important areas for consideration. These knowledgeable board members would be expected to contribute to corporate competitive advantage (March, 1999). Hence, a board versed in both vigilance and experience specic to the target companys industry could be more benecial to the acquiring enterprise. Furthermore, directors with experience as CEOs of acquiring rms may be positively associated with acquisition outcomes. If rms with prior acquisition experience tend to make better subsequent acquisitions because of the experience (Bruton, Oviatt, and White, 1994; Fowler and Schmidt, 1989; Haspeslagh and Jemison, 1991), then a major beneciary of the acquisition experience should be the CEO of the acquiring rm in terms of learned knowledge. Given our contention, we would expect that boards with members who are or have been CEOs of other enterprises that have recently made major acquisitions will aid the management of the rm they oversee in subsequently undertaking protable acquisitions. Consequently, we anticipate that boards with directors who have experience as CEOs of rms with prior acquisitions will in turn productively assist the management of the focal enterprise in making value-enhancing acquisitions. In our view, these directors may be expected not only to better monitor, but also offer superior counsel to the senior executives of acquiring enterprises. Finally, boards with directors who have experience as board members of other merging enterprises may likewise benet the management of the acquiring rm through their control and advice. Board members with past acquisition experience should serve as key sources of information regarding potential acquisitions. Board members who are or have been members of boards of other corporations and oversaw major acquisitions have likely developed relevant knowledge that can be benecial to the management of the rm contemplating a major acquisition. Individuals can capitalize on lessons learned by way of related experiences (Dearborn and Simon, 1958). Based on our elaboration, we offer the following hypotheses: Hypothesis 1a: At the time of an acquisition announcement, more independent outside board members will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience relevant to the target rms industry.
accounting rms, or legal rms (sometimes known as grey directors) have also been found to be less effective (Ryan and Wiggins, 2004). Thus, independent outside directors are needed to monitor the decisions of corporate insiders. Consistent with Wright, Kroll, and Elenkov (2002), we refer to independent outside directors as those who neither have business ties to the enterprise on whose board they serve, nor are they employed in an occupation that might cause them to seek to ingratiate themselves to rm management. Outside board members directly or indirectly monitor managerial decisions. Hence, they perform the function of decision control so that costly executive decisions can be confronted. These board members can appropriately affect specic events, such as corporate diversication. We shall remember that outside board members may be motivated to be vigilant in order to protect their professional reputations in director labor markets (Fama, 1980; Fama and Jensen, 1983). Our discussion implies that, based on agency theory, independent outside board members are expected to be vigilant with respect to the protection of shareholder interests. Although vigilance is needed, the presence of vigilance without relevant expertise acquired by experience may not enable the board to contribute optimally to acquisition performance. We contend that a board can be more effective if the vigilance stemming from the presence of independent outsiders is complemented by the presence of appropriate experience, enabling the board to better monitor and offer guidance to senior managers. Just as a rm as a totality accumulates experience in certain internal activities, and thereby attains expertise in those activities (Haleblian, Kim, and Rajagopalan, 2006), directors may gain expertise via their external experiences. Therefore, board members with related prior external observations may bring specic valuable competence germane to the acquisition under consideration. In particular, board members with experience related to the industry of the target company can more accurately evaluate the acquisitions prospects for performance, given that they may be aware of the industrys barriers to entry, threat of substitutes, power of suppliers and customers, or intensity of rivalry. Presumably, experienced directors possess valuable knowledge of industry recipes, and are more likely to be instrumental in bringing to light critical elements of the industry environment and in focusing management

Hypothesis 1b: At the time of an acquisition announcement, more independent outside board members will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience as CEOs of acquiring rms. Hypothesis 1c: At the time of an acquisition announcement, more independent outside board members will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience as directors of acquiring rms. Interaction of blockholder directors and experience Agency-based research investigating the relationship between blockholder ownership and corporate outcomes has offered modest to strong support for such a relationship (e.g., Dalton et al., 2003; Kroll et al., 1997; Wright et al., 1996). We would expect that blockholders vested with the formal authority of board membership and afforded the opportunities to control management would be vigilant and have a signicant impact on corporate strategy, especially when such directors are confronted with a decision to ratify managements pursuit of a major acquisition. Although blockholders equity stakes likely increase a boards vigilance, the board may not possess the relevant knowledge gained through experience to contribute fully to acquisition performance. Blockholders are certainly vigilant given the concentration of their holdings, but this vigilance may not be sufcient in optimally contributing to board effectiveness. We believe that the inclusion of relevant experience on the board will make the blockholders more effective. Experienced directors presumably have learned from prior doing (Nelson and Winter, 1982) and prior performance feedback (Greve, 2003). In particular, boards with blockholders as well as directors with experience related to the industry of the target rm will tend to promote acquisition performance. Additionally, as suggested earlier, boards with directors who are or have been CEOs of other rms that have recently made major acquisitions should aid the management of the rm they oversee in completing protable acquisitions. We would expect that as CEOs, these directors have become acquainted with the nuances and
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complexities involved in navigating a successful acquisition. Therefore, blockholders on boards with CEOdirectors possessing merger experience should promote successful performance. By the same token, board members who are or have been members of boards of other corporations who oversaw acquisitions should be able to assist management via their gained knowledge. Consequently, blockholders on boards that include directors with acquisition experience should further contribute to acquisition performance. The foregoing discussion leads to the following hypotheses: Hypothesis 2a: At the time of an acquisition announcement, blockholder board membership will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members who have experience relevant to the target rms industry. Hypothesis 2b: At the time of an acquisition announcement, blockholder board membership will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members who have experience as CEOs of acquiring rms. Hypothesis 2c: At the time of an acquisition announcement, blockholder board membership will be associated with more signicantly positive outcomes for shareholders where the board also has outside directors who have experience as board members of acquiring rms. Interaction of director-owners and experience Jensen (1993) has argued that equity holdings align board members interests with those of shareholders and ensure more effective oversight of management. However, a meta-analysis by Dalton et al. (2003) found equivocal evidence of a meaningful relationship between board ownership (separate and apart from blockholder ownership) and performance, but these authors did not distinguish between inside vs. outside board members. Their descriptive ndings, nevertheless, did demonstrate some signicance regarding the impact of outside board member ownership on performance. Hambrick and Jackson (2000) suggest that ownership helps outside directors to identify with the organization and increases the likelihood that these directors will be vigilant as well as generous with their time and attention. Moreover, if there is an occasion in which owner-board members are likely
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another publicly held rm. In order to ensure that an acquisition studied represented a meaningful strategic event for the acquiring rm, the acquisition included must have had a value equal to at least 10 percent of the acquiring rms market capitalization (Franks, Harris, and Titman, 1991; Tosi and Gomez-Mejia, 1989; Wright, Kroll, Lado, and Van Ness, 2002). The announcement date of the acquisition and information concerning possible confounding events must have been available from the Wall Street Journal Index or the Dow Jones News Retrieval Service. Insider biographical and ownership data must also have been available from proxy statements, annual 10-K reports, Lexus-Nexus references, or the Disclosures, Inc. database. Given these requirements, of the original 500 acquisitions selected, 324 were retained. No single three-digit SIC code accounted for more than 7 percent of our sample, which suggested our results were not industry driven. Independent variables In order to test our hypotheses, we estimated the values of our independent variables as follows. Independent outside directors In order to have qualied as outside directors, the board members may have been managers of publicly traded rms (with no business links to the organization on whose board they served), executives of nonprot organizations, directors serving on multiple boards with no primary employer, venture capitalists, former military ofcers, government ofcials, or academicians (Wright, Kroll, and Elenkov, 2002). The number of such board members on the board was subsequently used in our analysis. Board member ownership
to engage management in the defense of their personal wealth, an event such as a major acquisition would likely be that occasion. Although equity holdings can be expected to increase board vigilance, we view outside director ownership as a necessary but not a sufcient condition for optimal board contributions to acquisition performance. The consideration of directors industry knowledge and acquisition expertise may also be necessary, as discussed earlier. By the same token, directors who have been CEOs or board members of acquiring rms may bring their learned knowledge to bear on the proceedings related to the focal acquisition. Our contention is consistent with the argument that actors tend to capitalize on lessons learned by way of related experiences (Dearborn and Simon, 1958). These elaborations motivate our nal hypotheses: Hypothesis 3a: At the time of an acquisition announcement, board member ownership will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience relevant to the target rms industry. Hypothesis 3b: At the time of an acquisition announcement, board member ownership will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience as CEOs of acquiring rms. Hypothesis 3c: At the time of an acquisition announcement, board member ownership will be associated with more signicantly positive outcomes for shareholders where the board also has outside board members with experience as directors of acquiring rms.
SAMPLE AND METHODOLOGY

Sample construction From various almanac editions of Mergers and Acquisitions, we randomly selected 100 acquisitions of publicly traded rms made by other publicly traded rms for each of the years 1997 through 2001 (totaling 500 acquisitions) so as to include both bull and bear markets in our sample frame. To be selected, an acquisition must have been made by a domestic, publicly held rm and must have involved the complete acquisition of
Acquiring rm board member ownership was dened as the log form of the dollar value of outside board member ownership (exclusive of blockholder board member ownership). The value of such ownership was estimated by multiplying the number of shares the outside board members collectively owned by the acquiring rms share price on the day prior to the acquisition announcement. The data were taken from individual proxy statements. Earlier studies examining the inuence

of board ownership have often employed percentage ownership gures (e.g., Morck, Shleifer, and Vishny, 1988). Instead, we chose absolute dollar values of ownership as we anticipate higher dollar values of ownership, as opposed to percentage of ownership, motivate greater willingness to provide board capital and decision control. Blockholder board member ownership Blockholder board member ownership was estimated by rst identifying all outside board members who either directly owned 5 percent or more of the acquiring rms shares or represented an organization that did so (e.g., representatives of venture capital rms). The percentages of the acquiring rms shares held by such board members were then summed to reect the total ownership percentages of the acquiring rms held by blockholder board members. The ownership data were taken from the Disclosures, Inc. database and proxy statements. Board member expertise of the target rm industry In order for an outside board member to have been classied as having expertise related to the industry of the target rm, the board member must have been a manager or a board member of a rm in the same industry, as dened by the target rms primary three-digit SIC code. The director must have served as a manager or board member in such a rm within the 5 years prior to the focal acquisition announcement date. The values used in our analyses consisted of the number of such members on the acquiring rm board. Board member acquisition experience For a director to be recognized as having acquisition experience, he/she must have been a member of another board that presided over a major acquisition (representing at least 10% of the acquiring rms market capitalization) during the 5 years prior to the focal acquisition. The presence of these directors on the acquiring rms boards was represented by the number of such directors. CEO board member acquisition experience For a board member to qualify as a CEO with acquisition experience, he/she must have been the
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CEO of a publicly traded rm that completed an acquisition representing at least 10 percent of the acquiring rms market capitalization within the 5 years preceding the focal acquisition. The presence or absence of such a board member was represented by a dummy variable coded 1, if the acquiring rms had such board members, or 0, if not. Control variables Because acquisition outcomes may be subject to the inuences of other factors, several control variables were included that have been found to inuence acquisition outcomes. Relatedness of the acquisitions Relatedness between a target rms business and that of the acquiring rm has been found to signicantly inuence acquisition outcomes (e.g., Bruton et al., 1994; Hayward, 2002). Consequently, we included a continuous measure of relatedness as a control variable. Following Haleblian and Finkelstein (1999), we measured relatedness as follows. We identied the six most signicant SIC codes (in terms of sales) for both the acquiring and acquired rms, as well as their primary SIC codes. If a rm reported fewer than six SIC codes, we used all that were reported. We then assigned the following weights to indicate relatedness: in terms of the primary SIC code, if the acquiring rm and target shared the rst two digits, a score of 2 was assigned, if they shared the rst three digits, a score of 4 was assigned, and if they shared all four digits, a score of 6 was assigned. If they shared any of the SIC codes other than the primary SIC code, relatedness was scored as 1 assuming a two-digit match, 2 if there was a three-digit match, and 3 was assigned if there was a four-digit match. These data were taken from the Disclosures database. Form of payment We controlled for the nature of payment because acquisition performance may be inuenced by the form of payment used to complete the transaction (stock vs. cash; Datta, Narayanan, and Pinches, 1992; Loughran and Vijh, 1997). Earlier works suggest cash acquisitions tend to outperform stock acquisitions. Datta et al. (1992) argue that this relationship results from the speed with which a cash
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enterprise or at another enterprise), the CEO acquisition experience variable was coded as 1, or 0, if not. We used CEO experience vs. rm experience as the CEO is a likely repository of the experiential learning accrued from prior acquisitions. CEO ownership We included CEO ownership as a control variable as managerial ownership should motivate the pursuit of shareholders interests on the part of owner-managers (Jensen and Meckling, 1976). CEO ownership was dened as the log form of the dollar value of CEO common stock, restricted stock, and options holdings valued on the day prior to the acquisition announcement. We valued CEO common stock holdings by multiplying the closing stock price on the day prior to the announcement by the number of shares the CEO owned outright as well as in the form of restricted shares. Options were valued using the BlackScholes model (Black and Scholes, 1973). Values of common stock, restricted stock, and options were summed to represent the CEOs total equity positions in their rms. CEO ownership data were taken from proxy statements. Board size As three of our independent variables (independent outside directors, directors with target rm industry expertise, and board members with acquisition experience) were represented by the numbers of such members on the sample rms boards, we included as a control variable the number of seats on each board. Year of acquisition
deal can be consummated relative to a common stock swap, which reduces the chances of competing bids emerging. A cash purchase may also signal the market that the acquiring rms management believes their stock is undervalued, and therefore is too valuable a currency relative to cash to use in making acquisitions (Myers and Mujlaf, 1984). We included a dummy variable coded as 1 if an acquisition was paid for in cash, and 0 if paid for with common stock or a combination of cash and stock (Hayward, 2002). These data were taken from the Mergers & Acquisitions database. Acquisition size Studies of acquisition performance have found evidence that the relative size of an acquisition can inuence outcomes. Larger acquisitions, measured as a ratio of the target rms assets to those of the acquiring rm, have been positively associated with acquisition performance (Haleblian and Finkelstein, 1999). Thus, size of the acquisition was included as a control variable. The needed data were taken from the Compustat database. Acquiring rm prior performance Morck, Shleifer, and Vishny (1990) found evidence indicating that rms with superior performance prior to making a major acquisition tended to make more protable acquisitions. To control for prior period performance, we included acquiring rms total returns to shareholders for the year prior to the acquisition studied (Hayward, 2002). These values were drawn from the Compustat database. CEO prior acquisition experience Previous studies suggest that rms with prior acquisition experience tend to make superior subsequent acquisitions because of gained expertise (Bruton et al., 1994; Fowler and Schmidt, 1989; Paine and Power, 1984). We therefore controlled for such expertise by including prior CEO acquisition experience. Specically, CEO acquisition experience was scored as a dummy variable. If the acquiring rms CEO had presided over a major acquisition (equal to at least 10% of the acquiring rms market capitalization) in the 5 years prior to the acquisition studied (whether at the current
Dummy variables for each of the years represented in our sample (19972001) were included in order to control for temporal effects unique to the various years included in our analysis. Although these variables were included in all of our models, for sake of parsimony they are not presented in the results. Dependent variables The event study method was employed to estimate cumulative abnormal returns (CARs) that served as our dependent variable. In conformance with

the related acquisition studies (e.g., Haleblian and Finkelstein, 1999; Kroll et al., 1997; Lang, Stulz, and Walkling, 1991; Wright, Kroll, Lado, and Van Ness, 2002), we estimated CARs for two event windows: one covering the 3 days prior to, and following the acquisition announcement, and the other covering the 5 days prior to, and following the announcement. We use a span of 3 days and 5 days as information concerning the focal acquisition may leak out prior to the announcement (Asquith, 1983), and clarication of acquisition terms may not be fully revealed on the date of the announcement. By the same token, longer event windows may allow other news related to the acquiring rm, but unrelated to the acquisition announcement, to distort the CAR values (Brown and Warner, 1985). In order to ensure that our ndings were not inuenced by confounding events, the Wall Street Journal Index was searched for material events involving the acquiring rms during the event windows. Where such events were identied, the rms in question were dropped from the study. Event studies have been widely used in works seeking to assess the consequences for shareholders of important discreet events, such as the announcement of a major acquisition (e.g., Arthur, 2003; Brown and Warner, 1985; Chatterjee, 1986). The validity of this approach is supported by works that have demonstrated signicant relationships between event study results associated with merger and acquisition announcements and subsequent performance. For instance, Healy, Palepu, and Ruback (1992) reported a signicant relationship between abnormal returns associated with merger announcements and subsequent changes in cash ow. Kaplan and Weisbach (1992) found acquisitions that were subsequently seen as unsuccessful were associated with poor returns at the time of acquisition announcement, while those later judged to be successful were associated with relatively high returns at the time of the original acquisition announcement. Finally, Harrison and Godfrey (1997) reported nding acquisition announcement-related returns to be correlated with subsequent changes in ROA. These results tend to support Famas (1970) earlier contention that markets can be relied upon to adjust stock prices quickly to reect fairly accurately the news reaching the market. Building upon Jensens contention that although the evidence is not literally 100 percent in support of the efcient market hypothesis,
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no proposition in any of the sciences is better documented (Jensen, 1988: 26), Haleblian and Finkelstein argue that there is ample evidence for the market efciency assumption underlying event study methodology (Haleblian and Finkelstein, 1999: 41). In order to estimate the cumulative abnormal returns for our two event windows, we rst estimated that portion of each acquiring rms stock returns for each day of the event window that could not be anticipated given the return on the market for that day and the rms systematic risk level (i.e., its coefcient). The following equation denes the measurement of the unanticipated or abnormal returns (AR) for a given day: AR = Rit (i + i Rmt ) where Rit represents the return on rm is stock for day t, while Rmt denes the return on the market portfolio for day t, and i represents rm is anticipated return given no change in the value of the market portfolio. In order to estimate each rms and coefcients, we followed the related event studies (e.g., Haleblian and Finkelstein, 1999; Wright, Kroll, and Elenkov, 2002) and used the period from 300 days to 61 days prior to the acquisition announcement. The daily abnormal returns estimated for each of the days of the event windows were summed (across either the 3 to +3 day window or the 5 to +5 window) to arrive at individual CARs values. Methods To test our hypotheses, we estimated a series of hierarchical regression models that rst examined the linear relationships between acquisition performance and our various control variables. We subsequently entered our board vigilance variables (i.e., independent outside board membership, outside blockholder directors, and outside board member ownership), as well as our board experience variables (i.e., board members with target rm industry expertise, board members who are CEOs with acquisition experience, and board members who have served on boards of other acquiring rms). Thereafter, we employed moderated regression analysis and entered three sets of interactive terms with the rst set intended to test Hypotheses 1a, 1b, and 1c followed by a set testing Hypotheses 2a, 2b, and 2c, and another set testing Hypotheses
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are or have been CEOs with acquisition experience did not prove, by itself, to be signicantly related to acquisition performance. Later we will examine the possibility that such board experience inuences CARs by moderating the relationship between the level of board vigilance and CARs. Consistent with our expectation, having a higher number of outside board members with acquisition experience did prove benecial for acquiring rms. Results of the moderated regression models Models 3, 4, and 5 of Table 2 report the results of our hierarchical moderated regression models that examined the interactive relationships between our three board vigilance variables and our three board experience variables. Model 3 tests the moderating effect of our three board experience variables on outside board membership. The results provide support for Hypotheses 1a, 1b, and 1c in that all three interactive variables are positively and significantly related to CARs. Specically, the efcacy of outside board members in monitoring and advising management through the acquisition process is materially enhanced by having board members with target industry experience, CEO board members who have presided over acquisitions themselves, and board members with prior acquisition experience as board members of other rms. In order to examine the nature of these interactive relationships, we graphed the simple regression slopes of the relationships between outside board membership and each board experience variable at one standard deviation above and below the means of the interacting variables (Figure 1). In each case the plots indicate stronger positive relationships between outside board membership and CARs when that relationship is moderated by one of the three board experience variables. In effect, having more independent outside board members is helpful in enhancing acquisition outcomes, but is materially more benecial if the board has at its disposal relevant experience. Model 4 tests the moderating effect of our three board experience variables on blockholder board member ownership. These three interactive variables proved signicant, indicating that while the efcacy of an acquiring rms board is materially enhanced by having blockholder representation, the boards efcacy is improved even more with the presence of each of our three board
3a, 3b, and 3c. As stated in the results section, in order to explore more fully the meaning of our interactive terms, we plotted the simple regression slopes of these terms. Given that we have graphed the interactive relationships, our independent variables were centered (Aiken and West, 1991).
RESULTS
Table 1 presents the means and standard deviations for the variables used in the regression models. Also presented in Table 1 are the ndings of the correlation analysis. Although some of the correlations between the various independent and control variables proved signicant, variance ination factor values estimated in conjunction with our regression models did not suggest a problem with multicollinearity. As we included prior period performance as a control variable, we conducted DurbinWatson tests for autocorrelation. None of our models evidenced signicant DurbinWatson results. Results of the main effects model Table 2 presents a series of models intended to test our various hypotheses employing 3 to +3 day CARS as our dependent variable. (Although we do not report the results for 5 to +5 day CARs, the results were qualitatively the same as those employing 3 to +3 CARs.) In Model 1, we entered our control variables, of which three proved signicant: form of payment, acquisition size, and acquiring rm CEO ownership. All three variables were, as earlier anticipated, positively related to acquisition outcomes. In Model 2, we introduced our various independent and moderator variables. As expected, we found statistically signicant support for our position that independent outside board members, a higher percentage of blockholder board member ownership, and greater outside board member ownership are all associated with acquisition performance. Also included in Model 2 were our three board experience variables. We found outside board member target industry experience to be positively related to acquisition outcomes, ratifying our earlier expectations. These results indicate the presence of board members who have expertise in the target rm industry provides the acquiring rm with valuable experience. But the presence of outside board members who
Table 1. S.D. 1 2 3 4 5 6 7 8 9 10 11 12
Descriptive statistics and correlationsa 13 14
Variables
Mean
0.072 0.068 0.068 0.011 0.077 0.064 0.174 0.054 0.396 0.132 0.099 0.067 0.024 0.025 0.035 0.090 0.103 0.140 0.063 0.168 0.133 0.152 0.011 0.030 0.075 0.047 0.097 0.048 0.128 0.109 0.130 0.049 0.009 0.071 .113 0.097 0.168 0.044 0.109
0.139 0.182 0.073 0.148 0.121 0.068 0.119 0.283 0.335 0.173 0.133 0.081 0.074 0.060 0.071 0.120 0.014 0.116 0.051 0.207 0.149 0.015 0.094 0.022 0.135
1 3 to +3 day CARs 0.019 0.144 2 5 to +5 day CARs 0.018 0.169 0.886 3 Relatedness of 3.375 2.231 0.071 0.081 acquisition 4 Form of payment 0.269 0.437 0.138 0.143 0.139 5 Acquisition size 0.202 0.227 0.122 0.116 0.006 6 Prior year performance 0.165 0.467 0.063 0.057 0.083 7 Acquiring rm CEO 0.353 0.391 0.051 0.042 0.073 acquisition experience 8 Acquiring rm CEO 3.092 2.015 0.235 0.200 0.087 ownership 9 Board size 9.910 4.888 0.048 0.052 0.080 10 Independent outside 5.796 0.197 0.146 0.146 0.023 board members 11 Outside blockholder 0.124 0.119 0.193 0.221 0.109 board member ownership 12 Outside board 1.907 1.502 0.162 0.180 0.066 member ownership 13 Outside board 1.692 0.136 0.146 0.149 0.170 members with target industry experience 14 Outside CEO board 0.197 0.089 0.096 0.088 0.008 members with acquisition experience 15 Outside board 2.481 0.216 0.161 0.152 0.036 members with acquisition experience 0.113 0.027
Board Vigilance, Director Experience, and Corporate Outcomes 373
N = 324; correlations greater than 0.12 are signicant at 0.05; rs greater than 0.15 are signicant at 0.01. a Means and standard deviations of CARs are presented in decimal form of percentages. Relatedness of acquisition reects an SIC-based scoring system; form of payment, outside CEO board members and acquiring rm CEO acquisition experience are dummy variables; outside board member ownership and rm CEO ownership are in natural log form of millions of dollars; and board size, independent outside board members, outside board members with target industry experience, and outside board member acquisition experience are in numbers of board members.
374
Table 2. Hierarchical regression analysis: associations of corporate governance and board experience variables and interactive variables with acquisition performance Variables Relatedness of acquisition Form of payment Acquisition size Prior year performance Acquiring rm CEO acquisition experience Acquiring rm CEO ownership Board size Independent outside board members Outside blockholder board member ownership Outside board member ownership Outside board members with target industry experience Outside CEO board members with acquisition experience Outside board members with acquisition experience Outside board membership Board member target industry experience Outside board membership CEO board members with acquisition experience Outside board membership Board member acquisition experience Blockholder board member ownership Board member target industry experience Blockholder board member ownership CEO board members with acquisition experience Blockholder board member ownership Board member acquisition experience Outside board member ownership Board member target industry experience Outside board member ownership CEO board members with acquisition experience Outside board member ownership Board member acquisition experience Model F -statistic Adjusted R 2 Change in R 2 from Model 2
N = 324; p < 0.05;
Model 1 0.255 2.941 0.949 0.032 1.955 0.919 0.152
Model 2 0.267 2.570 1.006 0.048 1.771 1.022 0.351 0.958 0.121 1.291 1.062 2.132 0.756
Model 3 0.216 3.332 1.222 0.052 1.939 1.210 0.501 1.141 0.150 1.323 1.227 1.985 0.844 0.263 1.494 0.185
Model 4 0.281 2.768 1.133 0.066 1.940 1.272 0.413 1.078 0.153 1.109 1.210 1.931 0.739
Model 5 0.274 3.221 1.307 0.102 1.870 1.269 0.487 0.899 0.153 1.510 1.113 1.974 0.704
0.156 0.336 0.054 1.010 1.724 0.468 5.25 0.091 9.02 0.302 9.87 0.426 0.124 9.26 0.398 0.096 10.09 0.451 0.149
p < 0.01;
p < 0.001
experience assets. Figure 2 presents plots of the simple regression slopes of these three interactive variables, and graphically demonstrates that the relationship between blockholder board representation and acquisition performance is materially enhanced by higher levels of board target industry experience, the presence of CEO board members with acquisition experience, or higher levels of board member experience on other boards that have presided over major acquisitions. Model 5 presents our moderated regression analysis of outside board member ownership and the three board experience variables. Again, the
relationships between the three interactive terms and CARs are statistically signicantly positive, suggesting that boards with signicant outside board member ownership, when combined with board member target industry experience, CEO board member acquisition experience, or board member experience with acquisitions on other boards, result in superior acquisition outcomes for shareholders. Figure 3 depicts the plots of the regression slopes indicating materially stronger relationships between outside board member ownership and CARs when each of the board experience variables is at high vs. low levels.

(a) 12 10 8 6 CARs 4 2 0 -1.5 -1 -0.5 -2 -4 Outside Board Membership (b) 16 14 12 10 8 CARs 6 4 2 0 -1.5 -1 -0.5 -2 0 0.5 1 1.5
No CEO Board Member with Acq. Experience CEO Board Member with Acq. Experience Low Target Industry Experience High Target Industry Experience
375
0.5
1.5
-4 Outside Board Membership (c) 14 12 10 8 CARs 6 4 2 0 -1.5 -1 -0.5 -2 0 0.5 1 1.5

Low Board Member Acq. Experience High Board Member Acq. Experience
-4 Outside Board Membership
Figure 1. CARs and outside board membership (a) at high and low levels of board member target industry experience; (b) with and without CEO board member acquisition experience; (c) at high and low levels of board member acquisition experience. This gure is available in color online at www.interscience.wiley.com/journal/smj
As mentioned earlier, when regressed separately, the presence of board members who have served as CEOs of acquiring rms was not found to be signicantly related to CARs. The three interactive variables in which this variable was included,
however, all proved to be signicant. These results indicate that the presence of CEO board members with acquisition experience represents a pure moderator variablethat is, this variable only inuences CARs through its interaction with the
376

(a)
12 10 8
High Target Industry Experience
CARs
6 4 2 0
Low Target Industry Experience
-1.5
-1
-0.5
0.5
1.5
Blockholder Board Member Ownership

(b)
12 10 8
CEO Board Member With Acq. Experience No CEO Board Member with Acq. Experience
CARs
6 4 2 0
-1.5
-1
0 0.5 1 -2 Blockholder Board Member Ownership 12 10 8

High Board Member Acq. Experience Low Board Member Acq. Experience
-0.5
15 .
(c)
CARs
6 4 2 0
-1.5
-1
0 0.5 1 -2 Blockholder Board Member Ownership
-0.5
1.5
Figure 2. CARs and blockholder board member ownership (a) at high and low levels of board member target industry experience; (b) with and without CEO board member acquisition experience; (c) at high and low levels of board member acquisition experience. This gure is available in color online at www.interscience.wiley.com/journal/smj
independent variables, in this case, the board vigilance variables (Sharma, Durand, and GurArie, 1981). Finally, in order to enhance the robustness of our ndings we replicated our study using a 7 to +7 day window. We found our earlier reported results robust to the wider window. Because some of the earlier studies have not always evidenced a strong relationship between
rm performance and outsider board participation (e.g., Dalton et al., 1998), we sought to determine whether the other sets of interactive relationships we test might render our interactive terms involving outside board members insignicant. In order to explore the robustness of our interactive relationships involving independent outside board members, we replicated Models 4 and 5

(a) 12 10 8 CARs 6 4 2 0 -1.5 -1 -0.5 0 0.5 1 1.5 Outside Board Member Ownership (b) 14 CEO Board Member 10 With Acq. Experience 8 12 6 4 2 0 -1.5 -1 -0.5 -2 0 0.5 1 1.5 No CEO Board Member With Acq. Experience
377
High Target Industry Experience
Low Target Industry Experience
CARs
-4 Outside Board Member Ownership (c) 12 10 8 CARs 6 4 2 0 -1.5 -1 0 0.5 1 -2 Outside Board Member Ownership -0.5 1.5 High Board Member Acq. Experience Low Board Member Acq. Experience
Figure 3. CARs and outside board member ownership (a) at high and low levels of board member target industry experience; (b) with and without CEO board member acquisition experience; (c) at high and low levels of board member acquisition experience. This gure is available in color online at www.interscience.wiley.com/journal/smj
of Table 2, but included in each the interactive terms that contained outside board membership. As shown in Table 3, when we included the interactive terms of which outside board membership was an element with either of the other two sets of interactive terms, all interactive terms retained their signicance.
DISCUSSION AND IDEAS FOR FUTURE RESEARCH

Much of the extant governance literature emphasizes boards propensity to engage in decision control without adequately considering whether directors have the relevant experience to enable them
378

Table 3. Associations of corporate governance interactive variables with acquisition performance: a test of robustness of the effects of independent outside board members Variables Relatedness of acquisition Form of payment Acquisition size Prior year performance Acquiring rm CEO acquisition experience Acquiring rm CEO ownership Board size Independent outside board members Outside blockholder board member ownership Outside board member ownership Outside board members with target industry experience Outside CEO board members with acquisition experience Outside board members with acquisition experience Outside board membership Board member target industry experience Outside board membership CEO board members with acquisition experience Outside board membership Board member acquisition experience Blockholder board member ownership Board member target industry experience Blockholder board member ownership CEO board members with acquisition experience Blockholder board member ownership Board member acquisition experience Outside board member ownership Board member target industry experience Outside board member ownership CEO board members with acquisition experience Outside board member ownership Board member acquisition experience Model F -statistic Adjusted R 2
N = 324; p < 0.05;
to exercise control effectively. We have advanced the case that traditional agency theory considerations may not be sufcient for describing the range of potential contributions an effective board can provide when management pursues a corporate acquisition. Results corroborate our belief that director experience complements agency issues in explaining returns to shareholders. We consider the importance of director experience in the context of three commonly employed agency factors associated with board vigilance: independent outside board membership, blockholder ownership, and equity holdings by outside board members. In each case, boards that include directors experienced in the target industry, directors with prior CEO experience with acquisitions, and directors with prior board experience with acquisitions are associated with signicantly higher returns than boards with only the agency variables represented. Thus, boards that include experienced directors provide valuable guidance for strategic decision making for rms contemplating acquisitions. In this view, boards are engaged in tasks related to control of managements decisions as well as guiding those decisions. Our study has relied on the performance expectations of a multitheoretic view of the role of boards of directors. The discussion of directors as vigilant overseers was based on agency theory. Our elaboration on the contributions of experienced directors was based on theorizing that learning takes place by doing (Nelson and Winter, 1982) and performance feedback on what is done (Greve, 2003). We have anticipated that individuals are inuenced by the knowledge gained from their past experiences (Beckman, 2006; Burton et al., 2002). Hence, directors are expected to capitalize on their accumulated knowledge as they perform related tasks in similar contexts across rm boundaries. Presumably, knowledge is grounded in experiences involving rm strategy and the rms industry environment (King and Zeithaml, 2003). Furthermore, as directors learn or accumulate knowledge from various professional experiences, they may feel enabled and become more engaged in contributions toward corporate value (March, 1999). Such contributions may be in the form of better monitoring and superior counsel. These observations are consistent with the theoretical premise that personal experiences may enhance the comprehension of what is experienced (Porac et al.,
Model 1 Model 2 0.279 2.916 1.150 0.057 1.927 1.149 0.421 1.092 0.147 1.160 1.185 1.899 0.752 0.249 1.440 0.179 0.148 0.340 0.258 3.016 1.299 0.108 1.900 1.185 0.391 0.891 0.150 1.489 1.123 1.967 0.711 0.270 1.462 0.193
0.052 0.967 1.681 0.459 10.23 0.481 10.79 0.527
p < 0.01;
p < 0.001
1989) and ones thought process related to the context of the experience (Huff, 1990). Therefore, via experience, directors not only will better learn the

specicities of acquisition strategies, but also the relation of such strategies to a particular context or a unique target companys industry (Reger and Huff, 1993). With these thoughts in mind, we offer suggestions for future research and practice. In the present study, we have adopted a broader perspective and examined variables linked to agency and experiential learning domains. Regarding the latter variables, our concern was with the inuences on acquisition outcomes of directors learned knowledge via similar experiences. It has been argued that similarities of past experiences shape exploitation behaviors (Beckman, 2006; Nahapiet and Ghoshal, 1998), culminating in enhanced efciencies. Future research might explore the effects on acquisition performance of different director experiences. Differing board member experiences may shape exploration behaviors (Katila and Ahuja, 2002), resulting in greater innovativeness. In this case, the effects on acquisition outcomes might be dissimilar to what our study has indicated. Alternatively, researchers could explore the ramications of directors with similarities as well as differences in experiences. The presence of similar and divergent experiences has been referred to as ambidexterity (He and Wong, 2004), implying that such experiences may shape exploration and exploitation behaviors on the part of board members. Given this possibility, the inuences on acquisition performance might again be at variance with what our work has shown. Future research would also benet by using a variety of measures and methodologies to capture the role of board members in general and director experience in particular. For example, we used a dichotomous measure in assessing a directors experience with acquisitions; that is, a director was coded as either having experience related to a major acquisition in the prior 5 years or not. Although our data did not allow for further distinction, a better measure would be the average number of acquisitions with which a director has had experience, whether as a CEO or a board member. The inclusion of degrees of acquisition experience could shed further light on the possible performance impact of optimum levels of experience. Additionally, the degree of relatedness of the industry in which prior acquisition experience was garnered may help explain how qualitatively different types of acquisition experiences might be strategically related to the industry of the focal
379
acquisition. Such an effort may allow for a deeper investigation of how directors implicit theories developed elsewhere (e.g., Bettis and Prahalad, 1995; Carpenter and Westphal, 2001; Dearborn and Simon, 1958; Walsh, 1995) may hinder or enhance acquisition outcomes in various industry environments. Besides director experience acquired from prior CEO or board appointments, industry and acquisition exposure of directors may also include knowledge obtained from previous participation on top management teams (TMTs) of other rms. The TMT literature has addressed the composition of top management teams in various contexts (e.g., Bunderson and Sutcliffe, 2002; Finkelstein and Hambrick, 1996; Hambrick and Mason, 1984; Priem, Lyon, and Dess, 1999; Wiersema and Bantel, 1992). The impact of prior TMT experience on board effectiveness in general and acquisition performance in particular may represent extensions of this literature of both scholarly and practical significance. It would be important, however, to assess the nature and involvement of TMT members in the acquisition process. CEOs are likely engaged in all facets of a major acquisition, whereas other TMT members may or may not be so engaged. For practitioners, the implication of our study is that rms contemplating acquisitions are better served when their boards reect important director experience attributes over and above those considerations associated with vigilance. Composing boards of directors should not be done haphazardly, but rather with a view toward the array of contributions effective boards may provide (e.g., Sonnenfeld, 2004). Moreover, perhaps rms need different kinds of boards in different situations. As rms evolve in terms of size and position, they may be more likely to acquire than be acquired, and the evolution of the board should take this eventuality into consideration. Our ndings suggest that, ideally, boards should be characterized not only by vigilance, but also by appropriate experience in other arenas. The need for effective governance has increasingly taken on a sense of urgency. Although numerous consulting services and pundits have emerged to address the governance problem, prudence is imperative, as some of the prescriptions being offered may not be anchored in sound research. According to Sonnenfeld, much of the advice from consulting rms and universities alike is often anchored more in clich s and myths than e
380

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ACKNOWLEDGEMENTS
We would like to thank L. D. Briggs and K. Matthew Gilley for helpful suggestions on prior versions of this article. We would also like to thank Editor Dan Schendel and two anonymous reviewers for their support and very helpful comments on various drafts.
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