2017 brainfood rau companyboardconnections 883x432 1

Company board connections

8 May 2017

The article at a glance

Companies increase both R&D and patenting activity if they have directors who ‘interlock’ with other companies, says new study co-authored at Cambridge …

Category: Insight

Companies increase both R&D and patenting activity if they have directors who ‘interlock’ with other companies, says new study co-authored at Cambridge Judge Business School.

Connections: Close up of chain mail. Shallow focus.

The “interlocking” of corporate boards – in which directors sit on the boards of different companies at the same time – significantly boosts both research and development (R&D) spending and patenting, according to a new study published in the Journal of Banking and Finance.

When the size of their corporate “network” expands (because their directors are hired by other firms), firms end up spending more on R&D, particularly if the shared director sits in the same technology space, and seek more patent protection abroad for patents they have already filed in their home countries.

“Our evidence suggests that shared directors serve as a channel for the transmission of information across companies which impacts both their innovative as well as strategic patenting behaviour,” concludes the study by academics based in Britain, the US and France.

The study focused on public companies in India following a corporate reform in India (somewhat similar to the 2002 Sarbanes-Oxley Act in the US) that gave rise to more non-executive directors and board interlocks. The authors say the results from India are generalisable to the rest of the world.

Raghavendra Rau
Raghavendra Rau

“We found a clear strategic effect from interlocking boards of directors on both patenting and innovative behaviour as measured by R&D spending,” says study co-author Raghu Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School. “The larger the board’s network, the more directors are likely to be exposed to and influenced by external information that can drive innovation.

“The impact of board oversight is particularly important regarding intellectual property, as IP is increasingly both a valuable intangible asset and a strategic tool as evidenced by many recent high-stakes court battles.”

The study – “Do board interlocks increase innovation? Evidence from a corporate governance reform in India” – is co-authored by Dr Christian Helmers of Santa Clara University, Dr Manasa Patnam of CREST-ENSAE (Centre de Recherche en Economie et Statistique), and Professor Raghu Rau of Cambridge Judge Business School.

In order to ensure that the study did not just capture the effect of newly hired directors, the authors assembled a subset of firms that were already compliant with the new regulation and hence did not have to change their board structures. These firms nevertheless did experience an increase in board networks because their directors were hired by other firms. This allowed the study to isolate the influence of directors who began serving on other boards, rather than the impact of newly hired directors.

The study looked at over a thousand Indian companies listed on the Bombay Stock Exchange and National Stock Exchange from 2000 to 2007, avoiding the impact of the ensuing global financial crisis.

It found that the average increase in R&D spending was around $200,000 (a sizable sum for India) as the result of having at least one director sitting on the board of another firm, and “this effect is larger the closer firms are in their technology spaces.” In terms of patents, the study found that interlocking directors increases the firms’ propensity to protect their domestic patents by strategically filing patents abroad.

The change in R&D behaviour is explained in part by interlocking directors’ knowledge of the competitive landscape: firms increase their R&D and patenting activity due to “peer effects” that reflect changes in average R&D and patenting by other firms in a company’s network of directors.

“The number of patent filings increases significantly following a board restructuring,” the study says. “We show that this is the result of a strategic effect, that is, firms file more patents on existing inventions after obtaining information of strategic value through directors that sit on other (potentially) competing firms’ boards of directors.”