Together with Luciano Rossoni and Alex Gonçalves we empirically investigate how the material and symbolic resources available in the board of directors’ network can be a powerful mechanism to increase the board’s strength in properly monitoring executives and controlling the opportunism of stockholders. Consequently, the board’s greater strength and privileged position may mitigate agency problems and reduce information asymmetry between equity-holding companies and securities analysts. Therefore, we have tested the hypothesis that boards with valuable relational resources, i.e. greater board social capital, are a relevant mechanism to mitigate firms’ cost of capital.
We define relational resources as those symbolic and material resources that do not belong to a company but that can potentially be mobilized through network relationships and by means of the board interlock. Board interlocks occur when a board member of an “A” company acts simultaneously on the board of a “B” company, creating a bond for the exchange of benefits. Relational resources, although they are one of the essential dimensions of social capital, are practically set aside in the board interlock literature, since most studies consider as proxy of board social capital the number of ties, at most, specifying the type of actor you are relating to.
Faced with the recurrent limitation in the literature on board social capital, we use a social capital proxy that captures at the same time the number of interlocks weighted by the relational resources. Indeed, we operationalize the board relational resources from the sum of the market value of all the companies that a firm has an interlock with. Therefore, firms that have ties with more valuable firms, in our proxy, have greater social capital. We advocate that our board social capital proxy especially has two advantages. First, ties with higher-value firms should potentially provide access to most valuable material and symbolic resources that firms of lower value. Second, we understand that directors from higher-value firms tend to have a higher reputation and prestige, which makes them stronger on the board. Stronger directors can act as more rigorous monitors, mitigating the opportunism of executives and controlling shareholders, even because there is a greater moral charge in the boardroom for them to act professionally.
Additionally, because these board relational resources are means for obtaining privileged information and differentiated knowledge, we also consider the market value of relationships based on the heterogeneity of such ties, measured through structural holes. Structural holes are rich ties in non-redundant relationships, more likely to have new and valuable information. According to these definitions, which are based on the premise that resources are unequally distributed in networks, we argue that board social capital allows effective access to financial capital by the companies with the most competitive costs. To demonstrate our argument, we analyze 137 companies listed in the Brazilian stock exchange between the years of 2002 and 2015, showing the effect of the board social capital on predictions of analysts regarding the implied cost of capital.
We chose the cost of financial capital because it is fundamental to firm leverage since it is one of the most important resources for publicly traded companies, whose financing strategies are fundamental for their survival and growth. For that, we have chosen estimates of the implied (ex ante) cost of capital, which is based on the prediction of analysts. So, we contrast our results with public and privately controlled companies. Problems and peculiarities inherent in public management restrict, or sometimes render unfeasible, the performance of the board members as a source of external resources.
Among these problems, we can highlight, for example: expropriation of the interests of minority shareholders by the state; management of antagonistic interests created by the state’s regulatory and regulatory function; and misappropriation of public resources to attend to their own interests, partisans or votes. These problems, which are inherent in state-owned companies, at least hypothetically, make it difficult for board members to freely exercise their role of monitoring executives and dominant shareholders and collecting external resources, which would lead to a lesser impact from board social capital on the implied capital cost of state-owned companies.
Our results pointed out that the board social capital reduces the implied cost of capital for private companies but not for state-owned companies. For these reasons, we checked whether our board social capital proxy was robust when we contrasted the effect on the implied cost of capital with other board structure variables: board size, number of interlocks and outsiders. Given the ability of dominant shareholders to mitigate the board effect, we also check whether the board social capital was significant when contrasted with ownership concentration. Using instrumental variables and systems of equations, we have also demonstrated that the board social capital mitigates the discount of the ownership concentration on the implied cost of capital. Finally, we section the sample according to the level of corporate governance in the Brazilian stock market, demonstrating that the board social capital only operates at higher levels of governance quality.