Do Investors Care about Director Tenure? Insights from Executive Cognition and Social Capital Theories

Governance scholars debate the value of directors as an effective governance mechanism. We contribute to the resolution of this debate by examining the value placed on outside directors by shareholders as evidenced by market reactions to director exits, given their tenure in the firm. Using empirical data from the departures of 238 outside directors, and drawing from human capital and agency theories, our results confirm that directors are more highly valued over a “sweet spot” tenure period between 7 and 19 years. Using abnormal stock price reactions to director departures, we find that directors in the sweet spot add on average 2.68 percent to firm value. Furthermore, in examining the S&P 1500, we find that a one standard deviation increase in the number of outside directors in the sweet spot results in a 1.67 percent decrease in cash compensation and a 3 percent increase in equity compensation for CEOs. Our results thus confirm that directors in the sweet spot are more likely to align the interests of CEOs with the interests of shareholders than directors who are not in the sweet spot.