August 04, 2006
the small-world of corporate directors
Posted by Brayden

How do innovations in corporate governance spread?  A large literature in sociology and management theory explores the diffusion of organizational innovations, borrowing heavily from the statistical methods of network research.  This research points to the corporate board as an important avenue for change.  This should warm the hearts of legal scholars who see corporate governance as primarily the responsibility of directors.  For sociologists the research suggests, however, that directors aren't necessarily making governance decisions, but they do transmit information from company to company, which in turn helps managers dealing with uncertainty make decisions.

The flow of organizational change depends greatly, then, on the presence of dense networks linking corporations.  If the network fragmented into cliques, information would not flow as quickly or fluidly.  Therefore, organizational scholars have a theoretically-derived interest in understanding how those networks emerge and change over time.  Recent changes in corporate governance may have made those networks less effective at transmitting information.  Board members are more carefullly scrutinized than in the past, perhaps making them less willing to serve on multiple boards.  Banks, which tend to be the central nodes in the inter-corporate network, lost some importance in the corporate world in the 1990s and shrunk the size of their boards.  This change may have affected the coordinative aspects of the inter-corporate network.  If banks no longer had expansive network ties with non-financial entities, the entire network may have changed its structure in the 1990s.

In a paper published in Strategic Organization, Jerry Davis, Mina Yoo, and Wayne Baker empirically examine the change in interboard networks from the early 1980s to 2001.  Their results indicate that, despite the fact that banks became less central actors in the network, the overall network did not change in its degree of connectedness.  Cliques did not form.  The network, in fact, still has a "small-world" structure, indicating that most corporate board members are only one or two links away from every other board member.

As our results show, corporate America is overseen by a network of individuals who to a great extent know each other or have acquaintances in common. On average, any two of the 4538 directors of the 516 largest US firms in the largest component in 1999 could be connected by 4.3 links, and any two of the boards are 3.5 degrees distant...our results suggest that the small-world organization of the corporate elite is an emergent property of networks qua networks and requires no coordinating mechanism whatsoever, for the same reasons that brains, power grids, and the World Wide Web are also small worlds. It appears that nearly any collection of firms that share directors with a few random ties will end up appearing like a well-connected elite, without intentional design (321-322).

The downside of connectedness may be that corporate directors have an inordinate amount of influence in society.  While the network structure helps spread "best" practices, it also may propagate an elite-class structure (see C. Wright Mills) that is fairly immobile. 

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