What is one thing that business students are told over and over and over again?
Network, network, network. Building meaningful relationships is the most successful way to connect with future employers and build rapport with future colleagues.
But now, scholars have found that making strong connections not only helps one’s career prospects but also helps increase a firm’s value.
Steven Balsam, professor of accounting, and So Yean Kwack, PhD ’16, found in their new study that top management employees who are connected to a firm’s CEO—for example, through an alumni network or having worked at the same company—are more likely to move further up the corporate ladder and less likely to leave their jobs. They also found that these meaningful connections are associated with an increase in a firm’s value.
Prior research examining connections and firm value found that when CEOs are monitored by friendly boards of directors, the lack of independence tends to adversely impact firm value. But Balsam and Kwack’s new research, titled “The impact of connections between the CEO and top executives on appointment, turnover and firm value” and published in the Journal of Business Finance and Accounting shows that when CEOs work together with top management employees as a tight-knit group, their connections can boost firm value.
“If the CEO is friendly with the top management team, it facilitates communication and collaboration amongst the team thus helping the team run more efficiently,” says Balsam.
Balsam cites Enron’s downfall and the subsequent Sarbanes-Oxley Act of 2002 (SOX Act), which dramatically increased the independence requirements of corporate boards, as another motivation for examining connections within a firm.
The SOX Act asserts that the board of directors must give the assurance of being independent of the audit subcommittees both in fact and in appearance. It was passed to ensure that public companies protect the rights of investors and prevent financial misstatements.
But the law was unable to prohibit individuals with less obvious relationships to the CEO and the firm from serving on their boards. Balsam and Kwack wanted to examine what happens when these individuals joined the top management team.
The role of the board and the top management team differ. The board exists to provide advice to —and monitor—the CEO. It’s in the monitoring that connections could impair independence.
In contrast, the top management team acts to jointly manage the firm, with subordinates providing advice to the CEO as the ultimate decision maker. In that scenario, connections can be valuable.
“It’s a matter of trust,” says Balsam. “You need to trust someone to seek out their advice.”
However, he says there are pros and cons to these relationships. “For example, if I (as a CEO) hire somebody because I know them and they are my friend, this could be bad for the shareholders because people might think you hired someone that is not as qualified. But because they’re your friend, you can rely on them more and they would be more likely to tell you the truth about a decision you make. This can have a positive effect.”
The bottom line of most research in accounting and finance is trying to identify the impact on shareholders and profits. And Balsam and Kwack answer these questions in their research by documenting a positive effect on a firm’s share prices.
“There’s an old saying, it’s not what you know, it’s who you know, and in academia, we like to think it’s some of both,” says Balsam. “But our research emphasizes that who you know matters—not only to you, but also to the companies by reducing turnover and increasing shareholder value.”
This article originally ran in On the Verge, the Fox School’s flagship research publication. To check out the full issue of On The Verge: Business With Purpose, click here.