Networks of Influence: Stakeholder Theory, Director Networks, and the Governance of Firm Resources

David Aldama-Navarrete (I will be taking the second module)

Introduction and Background

In this paper, I will explore the responsiveness of firms to the personal connections of their board directors. In doing so, I will investigate how the firm interacts with external stakeholders, and how firm relationships with third parties are mediated by the personal relationships of senior management.

The firm has been traditionally seen by economists as either a “production function” or a non-market mechanism for economic exchange, in which transaction costs are curtailed through the establishment of vertical supply chains. In this view, firm management acts as a planner that chooses inputs as to optimize production and maximize profits. The question remains of who internalizes value created by companies. An implicit assumption made by the classical literature is that the firm’s managers are solely “agents” of a “principal” who wholly owns the firm’s resources. In the traditional view, this principal –the owner(s) of the firm’s equity–captures all economic value added by the company.

Reality, however, is slightly more complex. The firm exists at the intersection of the interests of many parties with differing motivations and incentives. The interests of these parties (consumers, governments, consumers, host communities, etc.) are sometimes aligned, but often not. Firms must offer all of these “stakeholders” a modicum of benefit, lest they lose their “social license to operate”.

Stakeholder theory is a relatively new theoretical development[1] that seeks to make sense of the firm –insofar as the firm serves as a mechanism for value distribution to multiple “principals”. This theory posits that that multiple social groups –stakeholders –have “claims” on the resources and profits of the firm. In this view, managers are, to some degree, agents of all these groups vying for a share of the firm’s profits, and must –dynamically–allocate these accordingly.

The Social Networks Analysis Angle

Stakeholder groups, however, are represented by people. Furthermore, personal networks –social, professional, and civic–provide a conduit for the “informal contracting” by which stakeholder groups exercise pressures on the firm. This paper will try to uncover the mechanisms by which this informal contracting takes place.

Following Barnea and Guedj (2007)[2], I will map director networks and generate a variety of network measures for these. Also following these authors, the network matrix will be constructed as follows: for each firm and each year, a mapping of connections among the different directors in the sample will be created. Rows and columns will represent all directors for a specific year. If director i and director j sit together on a board, the value of cell (i, j) in the matrix will be 1; otherwise it will be 0.[3]

Hypotheses

The main hypotheses of this work are that companies are responsive to:

1. The personal interests of their board members, as revealed by their participation in other boards (of for-profit or non-profit organizations).
2. The interests of the personal connections of their board members, as proxied by the board memberships of these connections.

Responsiveness will be proxied by the likelihood of approving shareholder proposals that benefit these interests. A central issue in the analysis will be the determination of the maximal connection-path length for which responsiveness occurs. By means of exploratory data analysis, I also hope to derive additional hypotheses regarding the influence that director networks have on the behavior of the firm. I am particularly interested in the effects that tightly connected sub-groups of directors (cliques, k-cores, etc.) might have on their firms.

Data

For the purposes of mapping director networks, I intend to use the RiskMetrics Director database, which consists of a collection of Board Director data for each of the companies included in the S&P1500 stock index, from 1996 to the present.

For the purposes of determining the dependent variables, I will use the RiskMetrics Shareholder Proposal database, as well as the RiskMetrics Voting Results database, which tally–respectively–all shareholder proposals for each of the companies included in the S&P 1500 stock index and all voting results for management proposals for the same set of companies, from 1996 onward.

Potential data limitations and issues

The RiskMetrics databases are owned by MSCI, the market information firm. In order to access this data, an access license must be purchased. I have contacted the MSCI sales department regarding the possibility of purchasing a license for research purposes, but have not yet received a reply.  If I do not gain access to the necessary databases, I will have to construct director and voting databases from publicly available data, including shareholder reports, which will surely draw down sample size.

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[1] The birth of stakeholder theory can be traced back to R. Edward Freeman’s seminal work Strategic Management: A Stakeholder Approach, published in 1984.

[2] Barnea, Amir, and Ilan Guedj. "Director Networks and firm governance." Unpublished working paper, University of Texas–Austin (2007).

[3] Ibid.