The Grass is Always Greener on the Other Side
Board Composition in Dutch Professional Football
Personalia
Name: Jordy Johannes
Address: Zocherstraat 85-1, 1054 LW, Amsterdam Study: MSc BA Finance and MSc Accountancy Student number: S1550322
Telephone: +31615699941
Piece: Master Thesis
Institution: University of Groningen (RuG) Faculty: Economics and Business
Author: Jordy Johannes Student number: 1550322
Supervisor, MSc Accountancy: D.J.J. Heslinga
Supervisor, MSc Business Administration Finance: H. Gonenc Final date of Submission: Amsterdam, 16-4-2012
PREFACE
This Thesis has been written as a final part of my MSc Accountancy and MSc Business Administration: Finance. It was a long journey to reach this point of time after a slow start in the first years of my study period at the University of Groningen. Years with a lot of fun at student societies and several other additional activities were exchanged for a more serious life with the focus on the studies Accountancy and Finance and a job at the management of the Bavaria Bierkoerier Groningen.
I started my research in September 2011 which is focused on the board composition of Dutch professional football clubs. I wrote my Thesis at Pricewaterhouse Coopers during an internship and finished it in April 2012. The topic of this Thesis became during the research much more relevant because there was massive attention in the media on the composition of the executive and supervisory board of AFC Ajax. Therefore, I would like to thank our national hero Johan Cruijff for making my Thesis topic more relevant. Most of all I want to thank my parents and friends off course for the support during my study. Furthermore I want to thank my supervisors D.J.J Heslinga and H. Gonenc for their assistance during the writing of my Thesis. Finally, I hope you will enjoy reading this Thesis.
Jordy Johannes
ABSTRACT
This study focuses on the complexity of managing Dutch professional football clubs. From a finance and management accounting point of view some literature is discussed to give an adequate representation of the complexity of football club management in the Dutch professional football industry. Subsequently, an empirical analysis is done focused on the relationships between elements of the supervisory and executive board composition and financial healthiness of 34 Dutch professional football clubs in the seasons 2002/2003 until 2010/2011. The facts presented in this work reveal how the composition of the supervisory board has no significant influence on financial healthiness, although a significant negative relationship is found between supervisory board size and financial healthiness. However, some evidence is found between the composition of the executive board and financial healthiness. In particular board tenure plays an important role in the composition of the executive board because it has a significant positive relationship with financial healthiness. To a lesser extent, a minor relationship exists between executive board size, executive director age, executive board diversity and the financial healthiness of Dutch professional football clubs.
JEL Codes: G30, G32, G33, L83.
Key words: Executive board composition, Supervisory board composition, Dutch football industry, Agency theory, Stewardship theory, Solvency.
TABLE OF CONTENT
PREFACE ... 3 ABSTRACT ... 4 1. INTRODUCTION ... 7 1.1 Introduction ... 7 2. LITERATURE REVIEW... 11 2.1 General definitions ... 11 2.1.1 Agency theory ... 11 2.1.2 Stewardship theory ... 11 2.1.3 Capital Structure... 12 2.1.4 Trade-off theory ... 122.1.5 Pecking order theory ... 12
2.1.6 Performance measurement ... 12
2.2 Complexity of the professional football industry ... 13
2.3 The optimal capital structure of Dutch professional football clubs ... 15
2.4 The agency problem in the Dutch professional football industry ... 16
2.4.1 Municipality ... 17
2.4.2 Debt holders ... 18
2.4.3 Shareholders ... 19
2.4.4 Sponsorships ... 20
2.4.5 ‘Third party’ ownership of players... 20
2.5 Board structure ... 21
2.6 Supervisory board composition ... 22
2.6.1 Board size ... 23
2.6.2 Board tenure ... 24
2.6.3 Director age ... 24
2.7 Executive board composition ... 25
2.7.1 Board size ... 25 2.7.2 Board tenure ... 26 2.7.3 Director age ... 26 2.8 Board diversity ... 27 3. RESEARCH DESIGN ... 31 3.1 Variables ... 31 3.1.1 Independent variables ... 31 3.1.2 Dependent variables ... 32 3.1.3 Control variables ... 32 3.2 Research methods ... 33 3.3 Data collection ... 34
4. RESULTS ... 37
4.1 Descriptive statistics ... 37
4.2 Empirical results supervisory board ... 38
4.2.1 Regression analysis ... 38
4.2.2 Hypotheses ... 41
4.3 Empirical results executive board ... 42
4.3.1 Regression analysis ... 42 4.3.2 Hypotheses ... 45 4.4 Additional analysis ... 47 5. CONCLUSION ... 49 5.1 Conclusion ... 49 5.2 Limitations ... 50 5.3 Further research ... 50 6. REFERENCES ... 52 7. APPENDICES ... 58
Appendix A: Correlation matrices ... 58
7.A.1 Correlation matrix supervisory board... 58
1. INTRODUCTION
1.1 Introduction
Last June 2011, the curtain fell for football club RBC Roosendaal. On the 8th of June 2011, during the meeting of shareholders of NV RBC Roosendaal it was decided to request bankruptcy for the club in question. The club, which in 1912 was initially formed under the name Excelsior, had failed to provide sufficient financial resources for a possible reorganization of debt (Parool, 06/08/2011).
RBC Roosendaal after HFC Haarlem, which filed for bankruptcy in 2009, is the second Dutch professional football club which despite their rich history, were obligated to cease and desist in a very short timeframe due to financial difficulties. Synchronously, football clubs like BV Veendam, Fortuna Sittard and FC Eindhoven with acute financial shortfalls were recently saved from bankruptcy respectively by major sponsors and municipalities. The financial crisis is also affecting the football industry and has made 'only' two victims thus far. The question is whether these financial failures could be prevented and how continuity of professional football in the Netherlands can be ensured in the future.
In 2004, the KNVB introduced a new licensing system which was meant to check the financial policies of Dutch professional football clubs on a structural basis and to monitor the perpetual longevity of the entire Dutch professional football industry. Based on the Financial Rating System (FRS), the KNVB assesses clubs on ten parameters such as liquidity, solvency, operating and net income, profit forecasts and fiscal discipline. Depending on the outcome of this test, clubs are classified in one of three categories. Clubs in Category III are doing well, in class II are performing moderate and in class I are performing bad. Clubs in Category I are required to submit a remediation plan to the KNVB and are consequently placed under increased surveillance. Although RBC Roosendaal and HFC Haarlem stood under stringent financial oversight of the KNVB it was no longer possible that these clubs would be considered financial strongholds.
Due to the increasingly deteriorating financial issue troubling the Dutch professional football industry, in 2010 an independent working group was appointed led by former Secretary of Finance William Vermeend (Vermeend, 2010). The task of this committee was to evaluate the current licensing system and compile a report with specific recommendations about financial rules, supervision and corporate governance.
This report shows among other things, that the reputation of professional football in the Netherlands has been significantly damaged due to recent events of financial insecurity. This creates a negative cycle of concerns for the clubs because sponsors and investors do not want to be associated with financially unstable clubs. The financial crisis has even more clearly revealed the problems in Dutch professional football than before since the clubs are no longer saved by a stakeholder. These problems are consequences from previous years of 'amateurish' short-term policies incurring (unnecessarily) high level risk taking. This is partly because football is an emotion-driven business
(according to the media), where the pressure on club managers to perform well is very high. This is why board members often think too much from in a short term perspective and are involved in the business of speculating rather than watching the long-term continuity of the club. It is for example very common in the football industry to buy a player for a (too) high price at the end of the transfer deadline trying to achieve some sportive performances in the short term. The underlying problem of these practices is that the costs of a football clubs are rather fixed meanwhile the profits are highly dependent on sportive performances and public attention (Szymanski & Smith, 1997).
Furthermore, the complexity of the football industry is a factor that plays an important role in the need for financial healthy football clubs. The overall profits of the professional football clubs depends on the balance of the competition (Rottenberg, 1956; Neale, 1964). Every club wants to outperform their competitor, but the profits will drop on the long-term if this leads to a gap between the strength of the football clubs and eventually to an unbalanced competition. An unbalanced competition will lead to an overall decrease of the public attention and total profits in the football industry (Rottenberg, 1956; Neale, 1964). This complexity has also some influence on the optimal capital structure of football clubs. Under the assumptions of Modigliani and Miller (1958) it makes no sense for the value of a firm how it is financed. However, in the real world there are a lot of elements that influences the optimal capital structure for a firm. In the football industry is it of great importance to have a balanced competition and this can among others be reached by limiting the debt levels of the football clubs. Decreasing the debt (higher solvency ratio) of football clubs will lead to an increase in the balance of the competition and will therefore contributes to the continuity of the Dutch professional football industry.
A trend within the football industry is that many managers are former professional footballers who possess a significant amount of superior knowledge concerning soccer, but often have little or no experience in managing a company. This debate has recently ignited again in the case of appointing a new executive board at Ajax. But which features should meet an effective board within the football industry in order to be financially responsible managed? The agency theory (Berle & Means, 1932) and the stewardship theory (Donaldson & Davis, 1991) are trying to declare the behavior of supervisory and executive board members and how they can influence firm performances. The executive board members are managing the daily operational activities of the football club and the supervisory board members functions more as a monitor and advisor (Forbes & Milliken, 1999).
It seems that at this time and in the past, corporate governance has been overlooked in the football industry, in which the composition of the supervisory and executive board is an important part. By giving a lucid account of the role of board composition in Dutch professional football, a contribution can be made to the existing literature and furthermore serve as an insight to strengthen the financial security of Dutch football as a business and restore its international reputation. Previous literature puts forth how certain properties of board composition, have a relationship with the financial
performance of companies (Chamberlain, 2010). Consequently the hypothesis of this study revolves around the central question:
What is the influence of board composition on the financial healthiness of Dutch professional football clubs?
This main question will be answered through empirical research from annual reports and additional information out of databases. In the following paragraphs, the scientific relevance of the topics mentioned above will be discussed.
Practice shows that the sportive achievements of clubs are often prioritized above the interests of the financial results (Koopmans, 2001). To meet the expectations of sportive performances, disproportional financial risks are taken by board members of the clubs. The KNVB wants that the football clubs are better organized to ensure perpetual continuity of professional football in the Netherlands. Corporate governance can play a determining role in this process because it is a tool to mitigate the conflict of interests between stakeholders inside and outside an organization.
In England corporate governance at professional football clubs has been studied before (Michie & Oughton, 2005). Michie and Oughton's study is however limited in the sense that it is merely descriptive and lacks any hard data. They come to the conclusion that there is still considerable room for improvement in corporate governance at the management level of professional football clubs. In March 2011, a student of the University of Tilburg wrote a thesis about corporate governance in the football industry. This thesis is written for a major in Law and Management and focuses only on the legal aspects of corporate governance within the industry, but omits to place this in a finance or management accounting perspective.
The academic world is lacking any concrete research concerning the football industry specifically and its relation between the quality of elements of corporate governance and financial performance. However, previous literature shows that there is generally a strong correlation between the financial performance of companies and their quality of corporate governance (Black et al. 2005). To measure the quality of corporate governance, researchers often use elements of board composition as a relevant parameter.
The recent bankruptcies of two Dutch professional football clubs and the discussions surrounding the composition of the executive and supervisory board at Ajax has incited a reexamination of what constitutes a well-performing board within an emotion-driven industry. The relevance of this study can thus be derived by the following issues:
First of all, different researches show that a positive relationship exists between the quality of corporate governance and the financial performance of companies. So did Larcker et al. (2007) e.g. found a positive relationship between the quality of corporate governance and the future operating performance and future stock returns. Black et al. (2005) concluded that a causal relationship exists
between its own developed corporate governance index and high share prices in Korea. Renders et al. (2010) found a significant positive relationship between corporate governance ratings and financial performance.
Secondly, research within the corporate governance topic shows that the quantitative and qualitative composition of the board is an important element. This is illustrated by research of Yermack (1996), who found a negative relationship between the size of the board and the value of the company in a sample of 452 large industrial companies from the U.S. between 1984 and 1991. Black et al. (2005) found, in turn, a strong relationship between the composition of the board and the share price of the company. Several more researchers studied different elements of the composition of the board such as age, size, tenure and diversity. These theories have never been applied in the football industry, which is a different type of ‘sport’, and it is therefore interesting to scrutinize whether these theories also apply to the emotion-driven Dutch professional football industry.
In this study the impact of board composition on the financial healthiness of the football clubs in the Netherlands will be examined. This study tries to make a valid contribution to the transparency and continuity of professional football in the Netherlands. Because football is the ‘sport of the people’ and the professional division in particular has a great social involvement, this study will also be of social importance.
The theoretical framework on the topic of financial governance is diverse and elaborate. Existing academic works are mostly focused on the influence of corporate governance mechanisms, and in particular board composition, on the firm performance. However, any real empirical research lacks on the influence of board composition in professional football. The complex financial infrastructure of the football industry, which board members of the supervisory and executive board have to deal with, will serve as a backdrop in order to properly contextualize the degree of financial governance. Subsequently, empirical data will be further examined to establish certainty around the notion of whether board composition in Dutch professional football will influence the financial healthiness of a club. Furthermore, a regression analysis will be examined to test the single relationship between specific board characteristics and the financial healthiness of Dutch professional football clubs. Eventually this study tries to contribute to a better in-depth understanding of how to establish continuity in Dutch professional football
.
This study contains five chapters in total. After the introduction, the literature review will be described which will be the foundation on which several theories can be properly analyzed to come to a more lucid account of financial governance. Section three will describe the research methods and data used and in section four the results will be presented and analyzed. Eventually, in section five the conclusions arising from the results are discussed in reference to the literature.
2. LITERATURE REVIEW
In this chapter will be started with an introduction to the general definitions that gives a good overview of the topics that will be later on applied to the Dutch professional football industry. Subsequently the complexity of the football industry and the financing problems of the Dutch professional football industry will be described in detail. This will result in a need to well working corporate governance mechanisms which will be described. The composition of supervisory and executive boards plays a major role in this process. Therefore, a literature review about the characteristics of board composition will follow and the chapter will ends with the establishment of hypotheses.
2.1 General definitions
2.1.1 Agency theory
The corporate governance literature is dominated by the agency theory and, to a lesser extent, the stewardship theory. Due to the separation of ownership and control of firms these concepts try to clarify the relationship between owners (principals) and those who control (agents) the firm. The agency theory is characterized by the situation that the principal gives an agent some decision-making authority (Jensen & Meckling, 1976). Agency theory is concerned about the risks that entail this relationship between principals and agents. The principals on whom the concept is built, faces risks because there exist a conflict of interest, also called the principal-agent problem. An investor wants to receive an optimal return while the agent will act of self-interest (prestige, power and rewards) at the principal’s expense (Berle & Means, 1932). Reducing this conflict of interest will lead to some additional agency costs. These costs could contain reward structures for managers to align their interest with the shareholders interests for example.
2.1.2 Stewardship theory
In contrast to agency theory, stewardship theory suggests that managers (stewards in this theory) will act in the best interest of the firm and their principals and not out of self-interest. Therefore, stewardship theory ignores agency costs by assuming that the interests of stewards are aligned with interests of the firm (Donaldson & Davis, 1991). Managers can be seen as a team consisting individuals who might add useful knowledge to the firm. From this point of view managers will be even able to add value to an organization.
In the professional football industry it can be can seen that a lot of managers of clubs are people who have worked earlier for a particular club. These people have often played for the club or worked for the club in a function as a coach. These managers are more involved in the well-being of a football club because they care about the existence of the football club on the long-term. This will result in managers (stewards) who will act in the best interest of the football club and will avoid excessive risk-taking.
2.1.3 Capital Structure
An important proposition, developed by Modigliani and Miller (1958) in finance, is the debt irrelevance proposition. They state that under ideal conditions of perfect capital markets the total value of a company is unaffected by the proportion of debt in the company’s capital structure. This means that individuals and companies can borrow and lend money at a common interest rate and that there or no taxes, transactions costs and bankruptcy costs (Modigliani and Miller, 1958). This implies that the costs of debt are not influenced by higher financial risk of a company and therefore, the level of debt is irrelevant to the value of the company. However, in practice, the market has some imperfections, like transactions costs, bankruptcy costs and taxes. These imperfections are influencing the optimal capital structure of companies.
2.1.4 Trade-off theory
The trade-off theory (Kraus & Litzenberger, 1973) of capital structure is based on the idea that a company chooses how it will be financed. The company makes a decision about how much debt and how much equity will be used by balancing the costs and benefits of a particular capital structure. The presence of taxes in the real world plays a very important role in this process. An advantage of taxes is that it creates a tax-shield for the company because interest payments on debt are tax-deductable expenses. However, an excess in debt can lead to an increase of the bankruptcy costs of a company. As a result a company that is optimizing its overall value will focus on this trade-off when considering the amount of debt and equity to use for financing.
2.1.5 Pecking order theory
The pecking order theory of capital structure is also based on the idea that a company chooses how it will be financed. However, this theory tries to capture the costs of asymmetric information between insiders and outsiders of the company. The theory gives a hierarchy of financing sources for companies. Internal funds are used primarily for financing the form, if there are no sufficient internal funds the company will issue debt, and when the company is not longer able to raise debt, the company will issue equity as a last resort (Myers, 1984).
2.1.6 Performance measurement
To most corporate governance academics, corporate governance is taken as an independent variable and firm performance as a dependent variable. However, financial performance can be measured in several different ways. The most usual measurements of firm performance in these researches are: Tobin’s q, return on equity (ROE) and return on assets (ROA). However, for the professional football industry the use of the Tobin’s Q method is not appropriate to apply. Tobins’q is very difficult to compose for football clubs, because market values for football clubs are not measurable. In addition, ROE is not very relevant because not all clubs are legal the same organized and want to make a return on their equity.
As mentioned earlier on in this study, the most important aspects of improvement in the industry where the KNVB aim on is the general economic health of the market economy structure of the Dutch professional football industry. The solvency ratio is the most relevant parameter to measure financial healthiness because it is a measure of the debt to be repaid relative to the total assets of the firm available as a source of repaying the debt (Business Credit, 2006). The solvency ratio gives an indication on the risks of a firm to become in financial distress. The ROA could also be used as a performance measurement, however, this measurement and the solvency ratio measurement have a direct relationship with each other. Therefore, only one performance measurement for financial healthiness will be used in this study; the solvency ratio. Later on, in the section of the optimal capital structure of Dutch professional football clubs, an explanation will be given (from financing point of view) why the solvency ratio is a good measurement for financial healthiness of Dutch professional football clubs.
2.2 Complexity of the professional football industry
The football industry has some specific characteristics which makes this industry very special and complex. In a normal economic environment firms are considered to be profit-maximizers and they can benefit from minimal competition (Jensen & Meckling, 1976). However, a firm has to deal with rivalry firms because these firms also want to maximize their profits. This competition process disciplines the firm, it limits its financial flexibility and it should be aimed at preventing suboptimal behavior, such that management invests in value destructive projects (Jensen & Meckling, 1976). This result in an economic environment where firms can entry or exit the industry and prices of products will therefore decrease. In a situation of a monopoly, a firm can determine its own prices and will benefit from it. However, for a professional football club means a monopoly just a disaster because the clubs depend on each other to make some revenues (Rottenberg, 1956; Neale, 1964).
Professional football clubs are all individual sport and economic entities and have mutual interests in the continuity of their professional football league. The processes of a professional football club can be compared with a production company and analyze it as such by identifying the input, production process and output (Dietl et al, 2007). Most of the revenues of the clubs are derived from five different sources: merchandising, advertising, sponsoring, match day revenue and broadcasting rights. These revenues (financial resources), which can be seen as the output, depend very much on the popularity of the club and the performances of a team, because this will generate more public attention. In figure 1 the revenue cycle of professional football clubs can be seen.
Figure 1
Revenue cycle (KNVB Expertise, 2009)
Obviously, public attention increases in the run up to a championship game. Compared to an exhibition game, this output of a championship game exceeds the value of a regular exhibition game. The value of any game depends on the strength and popularity of the participating teams’ and the relevance for the championship because that will influence ticket and broadcasting revenue. Therefore, the value of the game can be regarded as the production process of a professional football club. However, one can classify the value-creation in three different stages (Dietl et al, 2007). In the first stage the individual club is covered, which suggest that the level of a team must be good enough to attract some attention. However, it is also important that the performance level of the opposing team is equal to that of the home team. The second stage of the production process is the championship itself where single games act as an input, because single games are composing together a competition. For this reason, a degree of sufficient balance in the competition is of great importance to reduce the chances on monopoly positions of particular football clubs in a league. Rottenberg (1956) and Neale (1964) have recognized early that a monopoly position of a team on the pitch will decrease the total profits of the football clubs as the championship becomes unattractive and the public interest demand will decrease. On the third stage, the Europe League and the Champions League are exclusively for the national champions and other clubs who are qualified based on their sportive performances. An extra revenue stream can also be generated by selling players. Input for the whole production process is of course the investment in players which forms in the end a team. These investments include transfer costs, salaries, and to a lesser extent, development of youth players.
Although in most of professional football leagues in Europe the individual clubs co-operate in an institution (in the Netherlands: Eredivisie CV) to look after common interests, it can be seen that in the last decades the economic and sportive gap between football clubs has significantly widened. With unprecedented amounts of debt, clubs invests in their team trying to outrun their opponents by purchasing overpriced players to hopefully maximize their winning percentage. At first sight, this looks a very ordinary state of affairs, however, from the theory behind the revenue model of a football
club we now know that an unbalanced competition will decrease the overall revenues in a competition (Rottenberg, 1956; Neale, 1964).
The problem in the professional football industry emerges from the fact that the total costs for a club in a season is relative fixed but he revenues are extremely variable (Szymanski & Smith, 1997). Every club invests in their team to achieve a particular level of sportive performances to reach a certain level of revenues that matches the costs. However, if the particular level of sportive performances, where is gambled on, is not achieved, the revenues will be lower because the public attention will be lower (see figure 1). This will lead to a loss and makes it for a club more difficult to invest in players to achieve the estimated sportive performances in a next year. It could even lead to the force of selling players what also may stand in the way of achieving the sportive performances. For the first year this is not immediately a problem but if this happens frequently a football club can come into a negative spiral.
Nowadays the KNVB and UEFA are trying to make professional football clubs financially healthier by developing rules that prohibit clubs from making enormous yearly losses and that clubs held huge amounts of debt. These regulators are therefore introducing the Financial Rating System (KNVB) and Financial Fair Play system (UEFA). Consequences for the clubs if they not comply with this could be: exclusion for European football competitions, point reduction and/or a reduction in the freedom to buy new players. These measures could in the short term lead to an increase in the negative spiral but could result on the long term to a better match of the costs and revenues of a football club.
2.3 The optimal capital structure of Dutch professional football clubs
In regard to the theories about the optimal structure there are some specific complexities in the Dutch professional football industry that provide an alternative perspective of these theories. One of these complexities is that not all Dutch professional football clubs are paying corporate taxes, because a great part of the football clubs is organized in different legal forms, they are either an association or a foundation. This means that these football clubs do not profit from a tax-shield if they raise their debt. However, these football clubs face bankruptcy costs of financial distress if they have an excessive amount of debt in their capital structure. Consequently, raising debt will lead to higher costs for these clubs while they do not benefit (no tax-shield) from it in regard to the trade-off theory mentioned earlier.
Furthermore, if a company operates in a sector characterized by high business risk, there is a high risk of financial distress (Beech & Chadwick, 2008). Because the profits of football clubs are very insecure while the costs are highly fixed, it can be said that the professional football industry is characterized by high business risk. A company with a high risk of financial distress will be faced with increasing costs of debt charged with by debt holders. Therefore, football clubs would benefit more from equity over debt in order to minimize any additional financial risk (Beech & Chadwick, 2008).
Another major issue that harms the overall professional football industry is the asset substitution effect. If the ratio of debt increases, management has an even more increased incentive to take excessively high risk decisions. This is because if a project is successful, the shareholders will profit from it and when it is unsuccessful the debt holders will be hit by the loss. Managers will undertake these risky projects (even with a negative NPV) if the company has a high debt ratio because they are forced by the shareholders with a voice during the shareholders meeting (Hillier & Titman, 2008). As a result, more debt will increase excessive high risk taking by managers from football clubs. This is the main reason why the continuity of Dutch professional football is harmed at the moment. However, the most important issue saturates around the manner in which high debt levels influence the continuity of the Dutch professional football industry in relation to the balance of the competition and more specifically, how this equilibrium is disturbed by these high debt levels of particular football clubs. In the short term, a football club can profit from a high debt level by outperforming their competitors. However, if this results in an unbalanced competition on the long run, this can also have negative influences on the profits of the clubs with high debt levels, because the competition will be less attractive for the public. As a result, the overall profits of the competition will decrease and therefore the continuity of Dutch professional football clubs can become uncertain. The regulators in the professional football industry like the KNVB, UEFA and FIFA, want to improve the balance in the competition by reducing the debt levels of football clubs by more strict regulations. Thus, in case of the Dutch professional football industry, the solvency ratio (which measures the height of debt compared to the total assets) can be seen as a tool for measuring the financial healthiness of Dutch professional football clubs in regard to the continuity of the Dutch professional football industry.
2.4 The agency problem in the Dutch professional football industry
In retrospect to the earlier discussed complexity of the professional football industry, it can be argued state that a football club will benefit from sportive performances because it leads to more public attention and higher revenues. However, to achieve these sportive performances, indulging in the practice of financial risk taking is inevitable for managers in order to keep up with competing clubs. The problem is that managers benefit when they take this risk and achieve sportive performances, without baring a downward risk if sportive performances will not be achieved. When the team of a club performs well, the board’s financial “speculation” is laureated, but when a team books disappointing results, the speculation remains without negative consequences for the board. Either way, the board is not criticized for any financial outcome as a result of its financial speculation. However, when a stakeholder invests in a professional football club he or she is met with certain benefits when the set out sportive performances are achieved but also faces some downwards risks if the set out aims are not achieved. In the past, stakeholders cared little for downward risk because there
was always a party to fill the financial gap of the football club (KPMG, 2003). This means that the sky was the limit and that even managers that took excessively high risks, were not punished for their mismanagement. Practice shows that in the recent financial crisis these stakeholders were no longer able or prepared to save a football club, resulting in bankruptcy. Football clubs will also be penalized by regulators of the professional football industry if the club is not healthy since the introduction of the new rules. As a result, stakeholders who invest in a football club face much more downward risk then in the past and it will increase the financing problem in this industry. The following section will discuss which stakeholders are liable to precarious speculative decisions by excessive risk-taking by board members of a football club. There are several problems concerning different agents and principals in the Dutch professional football industry. First of all, it is important to make a clear distinction (figure 2) between the different economically dependent stakeholders of professional football clubs.
Figure 2
Stakeholders Dutch professional football clubs
2.4.1 Municipality
Municipalities are playing a significant role in the existence of a great part of the professional football clubs in the Netherlands. Municipalities often finance or refinance the construction of a football stadium in exchange for a share of the stadium revenues. KPMG (2003) studied the cash flows from municipalities to Dutch professional football clubs and concluded that the past decade, 80 percent of the total amount of aid was related to the financing of the stadium. The remaining twenty percent consists of other financial relationships between municipalities and football clubs (KPMG, 2003). In
Football Organization
Shareholders
Sponsors
Municipality
Debt holders
Player
investment
funds
the context of illegal subsidies to businesses from the municipalities, these cash flows are critically monitored by the European Commission. However, stadium funding falls outside of the scope of the European Commission (Koopmans, 2003).
In practice, a private entrepreneur is unable to carry the entire funding of a football stadium without government intervention due to a too low of an economic return on investment. Municipalities can, in contrast to private investors, also profit from social benefits that a stadium may entails. Social benefits could include the positive image of the city, consumer spending at events, activities around the stadium (hospitality), employment and the importance for the sports and welfare department of the municipality (KPMG, 2003). Hamil et al. (2003) argue that the development of a football stadium could help to stimulate economic activity and growth, creating employment and increasing the demand for services in a particular area. In addition, the economic profits for a municipality will also be higher in contrast to a private entrepreneur, because municipalities can economically benefit from issuing permit, which the private entrepreneur is unable to claim.
The social and economic benefits from a football stadium by a municipality can be improved by an increase of public attention of the football club (KPMG, 2003). However, excessive risk-taking by the management of a football club, to achieve successful sportive performances and therefore more public attention, can lead to a financially negative spiral due to mismanagement. If the football club subsequently goes bankrupt, the stadium is largely useless because it is a very specific asset that becomes worthless. Therefore, it can be seen that many municipalities financially support a football club when the club’s situation becomes financially distressful. They do this by increasing their stake in the stadium, buying the ground of the stadium or providing a loan to the football club (KPMG, 2003). However, since the beginning of the financial crisis, municipalities are no longer prepared or able to financially save the football club and their investment in the stadium. A lot of criticism is uttered by society towards the practices of municipalities indirectly financing football clubs with public funds in these times of economic crisis. Consequently, municipalities have an increased interest in the risks a manager of a football club takes because of the perpetual lingering possibility of bankruptcy, which leads to an agency problem.
2.4.2 Debt holders
In the past, professional football clubs have received preferential treatment in obtaining loans. Normally, at a company, shareholders try to increase the value of a firm by taking excessive high risks. This increased risk for debt holders is also called the asset substitution problem (Jensen & Meckling, 1976). The primarily biased focus of the shareholders of a football club on successful sportive performances can lead to financial mismanagement because they have no real interest in the amount of debt. However, because investors and municipalities were always willing to invest in a football club and because the professional divisions had a closed system, where entry and exit was practically impossible, clubs could hardly go bankrupt. This situation reduced the credit risk to a
minimum of providing a loan to a football club. So if there was in the past a situation of mismanagement, the provider of a loan was not financially harmed because the club was always saved by one of these parties. In this situation it eliminates the asset substitution problem in the football industry (KPMG, 2003).
However, in 2010, the KNVB put an end to the closed system and made it possible for amateur clubs to enter professional football and for professional clubs possible to exit professional football. In addition, the financial crisis has encompassed a changed financial environment for the football clubs since investors and municipalities are no longer per definition prepared, but moreover not able to save the club when they are in financial distress. This has led to the bankruptcy of HFC Haarlem and RBC Roosendaal and made clear to debt holders that credit risk for football clubs has increased in the present situation (increased agency problem). Therefore, debt holders are more cautious in giving out loans to a football club because they too can become a victim of financial mismanagement rather than before.
2.4.3 Shareholders
Professional football clubs look like regular organizations in respect to economic aims. There are however some deviations. Originally, a football club was not a profit maximizing firm, because all their capital and revenues will be invested in players to achieve successful sportive performances (Szymanski & Smith, 1997). The majority of shareholders are wealthy fans who want to financially support their favorite football club in order to have a prominent voice during the shareholders meeting. They are not concerned with return on investment and will continue to financially support the football club with additional investments when the club is in financial distress. The main priority for these shareholders is that their team will be the next national champion. However, since the start of the financial crisis, shareholders are no longer prepared or able to save a football club, resulting in the bankruptcies of HFC Haarlem and RBC Roosendaal for example. From the decision theory of economics we know that investors are relatively more averse to big losses than that they are happy with profits of the same proportion, also called loss aversion. This theory suggests that people experience losses twice as powerful as gains psychologically (Kahneman & Tversky, 1979). Despite that investors are not concerned with the return on their investment in a particular football club, in the present economic environment the investor wants to limit his losses however.
Furthermore, football clubs are increasingly seen as an investment opportunity which also increased this agency problem. An example is the recent investment of Merab Zjordania in all the shares of Vitesse. Zjordania is a Georgian business man with a football background, but he had no further relationship with Vitesse. He decided to invest in Vitesse when he was convinced about the potential growth of Vitesse to become a top club in the Netherlands. His philosophy behind becoming a top club is to invest in young players with a lot of potential and sell them after a few years for a significantly higher transfer price to raise funds.
In addition, pressure on managers from shareholders to take excessive risks must be reduced since debt holders treat football clubs more like regular companies (Verdoes et al., 2010). If they continue with excessive risk-taking, the providers of loans will increase their interest rate since they bare higher credit risks and that will reduce the profit for shareholders.
2.4.4 Sponsorships
A great part of the revenues of a professional football club exists out of incomes from sponsor deals. In general the sponsor deals in the Dutch professional football industry have a maturity of 3 until 10 years. The amount of money spend on these deals depends on the expected exposure that will be reached by sponsoring a particular football club. Most of the time the amount of the sponsorship is a fixed payment per year, but the amount of exposure for the sponsor can fluctuate because it depends on the public attention of a football club. To reach the expected exposure for the sponsor, management can decide to take excessively high-risks. However, financial mismanagement can arise in order to reach this exposure. Consequently, the football club comes in a financial negative spiral that in the worst case can lead to regulation. This can result in a significant decrease in the exposure for the sponsor while the costs of the sponsorship are still fixed. So after signing the contract, the sponsoring company is very dependent on the policies of the management and the performances of the football club which can be seen as an agency problem.
2.4.5 ‘Third party’ ownership of players
In the last decade a new phenomenon has been introduced in the football industry: ‘third party’ ownership of players. These parties invest partly or wholly in the economic rights of football players and will get in return a part of the profits that will be made when the players are transferred (BBC Sport, 27/10/2011). In England and South America are some great investment funds active that invests in players from various professional football clubs. In the Netherlands it can be seen that the investment funds are affiliated with a particular football club. They invest in young players with the potential to become a top player to make a good return on their investment when these players are sold. The investment funds gamble on an increase of the value of a player to get a return. From a financing perspective this means that the investment fund owns a particular part of the assets from the football club while the payoff is very unsure. This can be seen as a very special form of shareholder ship because the investors get nothing to say about the policy of the football club and the appointment of the directors of the club.
However, there are a lot of elements from the policy of a football club that can significantly influence a player to become a star or a loser (Verdoes et al., 2010). The development of a player depends on the quality of his teammates and the trainings facilities offered by a particular football club. Players can piggyback on training programs they enjoy, as well as present themselves during the games (Verdoes et al., 2010). The value of a football player when he is transferred depends on the quality of the player, his potential, the length of his contract, but also indirectly on the performances of
his team because a well-performing team will get more public attention. In summary, this means that the policies of a football club can influence the development and therefore the value of players from the investment funds. In addition, because in the Netherlands these investment funds are focused on one particular club, the investor’s investment portfolio of players will become very risky. In comparing these players with stocks, there is a high correlation between them and therefore the well-being of the club which is of great importance to get a good return on their investment. A negative spiral due to mismanagement can lead to the devaluation of the players of the investment fund and lead to an agency problem as well.
2.5 Board structure
The agency problems which are described above can among others be reduced by implementing corporate governance mechanisms. Regulators like the KNVB, UEFA and FIFA can be seen as an extern corporate governance mechanism for Dutch professional football clubs and are playing a very important role. However, regulation is not the only corporate governance mechanism that is needed for a change in this industry as we now know. Solid strategic policies from executive directors and well monitoring and advising supervisory boards are also of great importance to reduce the agency problems earlier described. In the next section the focus lies on the structure and composition of boards.
Specifically in the Dutch professional football industry, board composition is a really hot topic at the moment. A clear management distinction exists between two types of board structures which are most prevalent used: one-tier and two-tier (Maassen, 1999). The one-tier model is mostly used in Anglo-Saxon countries like the US and Canada and distinguishes itself by one board that contains executive as well as non-executive directors. The board contains auditing, remuneration and selection committees. The classic one-tier model is dominated by the Chief Executive Officer (CEO) who is the chairman of all these committees. Contrary to the one-tier model, the two-tier model explicitly make a distinguish between executives and non-executives. In this model the non-executive’s task is to supervise the executives. In the Netherlands the two-tier structure is most commonly used and mandatory for some firms which explain the distinction between the roles of executives and supervisors. Because professional football clubs have different legal structures, a description of the different roles of executives and supervisors is required for a transparent overview of governance efficiency. Among an executive in this study is meant “a person who is responsible for the daily running of the club”. He or she can have a place in an executive or management team or in the board. A supervisor is “a person responsible for monitoring the directors and is as such not involved in daily operations of the club" (KNVB Expertise, 2011). The terms of director and board members will be used as collective nouns.
In respect to a clear analysis of the board structure, a distinction between the tasks of the supervisory and executive board is necessary to draw a clear picture of their relationships with the
measurement embodied by the solvency ratio. Hereafter, the tasks of the boards will be briefly described and to reveal the extent to which they are able to influence the financial healthiness of a professional football club. This will result in two main hypotheses and some sub-hypothesis for particular characteristics of supervisory and executive board composition.
2.6 Supervisory board composition
Supervisory boards can be characterized as large, elite, and episodic decision making groups that face complex tasks regarding strategic issues. The specific tasks that are most relevant for supervisory board members are ‘control’ and ‘service’ (Forbes & Milliken, 1999). The supervisory board’s control task refers to the monitoring function on the executive board to align the interest of shareholders and managers. Therefore, supervisors can be used as a corporate governance mechanism that reduces agency costs. At the same time financial monitoring is a legal duty of supervisors (Monks & Minow, 1995).
The service task of the board refers to the potential to provide advice and counsel the CEO and other top-level managers. Furthermore, it needs to ensure, legitimacy, and supply channels for communication and gaining preferential access to commitments or support from important resources outside a firm (Forbes & Milliken, 1999; Hillman et al., 2007). Therefore, the service task can also be termed as “the provision” of resources (resource based view).
Figure 3
Board processes and their impacts on board effectiveness (Forbes & Milliken, 1999)
However, the ‘output’ that these boards produce are entirely cognitive in nature, because supervisors are not involved in the implementation processes. Therefore, one can suggests that the efficiency of supervisory boards will largely depend on social processes, the exchange of information and critical
discussions (Butler, 1981; Jackson, 1992; Milliken & Vollrath, 1991). Forbes and Milliken (1999) developed a model (figure 3) of board processes and their impacts on board effectiveness. We use ‘board characteristics’ as an input and ‘firm performance’ as an output for this model’. This suggests that board characteristics will indirectly influence firm performance.
As we can observe from figure 3, it can be suggested that board demography is the absolute input in this model. Therefore, the following section of this paper will discuss board demography which can significantly influence the decision-making process of the board that will lead to firm performance.
2.6.1 Board size
Board size is not really a demographical condition, but it is a very important and a much studied board characteristic which can have a significant influence on the decision-making process of the board. Therefore, it can also be stated that this characteristic is very close related to the demography of a board because it indirectly influences the average age and tenure of the board.
From a resource dependent and stewardship theory perspective, it is safe to argue that companies are better off with large boards. An increase in board members would provide more expertise and access to resources. With more expertise and access to resources large boards are likely to have more presence of knowledge and skills and therefore will also have a higher use of knowledge and skills. These resources can include relationships with regulators, access to sponsor markets, relationship with other professional football clubs and access to the capital market (Ning et al., 2010). Large boards are also more likely to contain diversity in background and will thus have more cognitive conflicts between board members, which can lead to higher quality advice to management (Forbes & Milliken, 1999). The resource based theory is empirically supported by Dalton et al. (1999). They found a non-zero and positive correlation between board size and firm performance.
However, from an agency-based perspective, Lipton and Lorsch (1992) and Jensen (1993) argue that large boards can be costly because of increasing coordination and communication problems. Decisions made by larger boards contain more compromises and are less rigorous than decisions made by smaller boards (Hermalin & Weisbach, 1991). It can be stated that, due to a larger board, it is more difficult for individuals to use their own knowledge and skills effectively. Large boards face problems building interpersonal relationships which reduces cohesiveness and can lead up to a so called “free riders problem” (Forbes & Milliken, 1999). Jensen (1993) states boards have to be kept small, because over-sizing will lead to less effective functioning boards. In line with this argumentation Eisenberg et al. (1998) state that a larger board causes greater agency problems and costs. Furthermore, Yermack (1996) found an inverse correlation between board size and firm value.
2.6.2 Board tenure
The definition of board tenure covers the number of years that an individual board member has served in the supervisory board of a professional football club. The theory about board tenure contains conflicting views that will be discussed hereafter.
Long-term board member engagement will provide these members with important knowledge about the football club and its business environment. Consequently, long-tenured board members are associated with greater experience, commitment, and competence (Vafeas, 2003). From this point of view the supervisory board will provide high quality advice to top management and will better perform the monitoring function. Board members, who are serving the supervisory board for a long time, will increase the cohesiveness and use of knowledge and skills from the board as well and thereby increases task performance (Forbes & Milliken, 1999). Another specific advantage in the professional football industry for tenure board members is that these members have a more long-term view (Buchanan, 1974). They are better aware of risks and have less intention to manifest them on the short-term. In effect, supervisory board members with a long tenure will have a positive influence on the firm performance. Finally, Vance (1983) even argues that retirement of board members is a waste of talent and experience.
However, long board tenure decreases conflict of interest due to a shared understanding of issues (Forbes & Milliken, 1999). It reduces intra-group communication, learning effects and isolates groups from key information sources (Katz, 1982; Vafeas, 2003). Therefore, it can be stated that there are some advantages of board members with a short tenure. Board members who are serving a short time will have more diverse perspectives and will increase task performances (Forbes & Milliken, 1999). The bounded rationality view suggests that appointing a new board member will lead to new insights (Simons, 1991). The monitoring and service role as well will be approached with innovative perspectives when new board members will be hired.
2.6.3 Director age
Director age is a very interesting demographic element of the supervisory board as well. Most of the time, supervisory board members are older than executive board members. The classical thought about director age is that there is a positive correlation between director age and firm performance.
The principal reason for this classical thought is that older board members gathered knowledge from a broad range of experiences (Cochran et al., 1984). An older board may ensure that decisions are based on a higher degree of business experience (Rose, 2005). From the resource dependency and stewardship theory it is arguable that older board members will provide more knowledge and skills and therefore will increase firm performance.
However, Rose (2005) suggests that younger directors will be more innovative and therefore create more opportunities for a firm. Younger board members will be more vigorous and provide more continuity into the future than older board members will (Cochran et al., 1984). Younger board
members will better understand current trends as well because they show less sense of history. One can state that young board members will increase cognitive conflicts within the board and as a result the performance of the board and firm will increase. Vance (1983) found a positive relationship between young board members and growth opportunities. However, he did not found a positive correlation between the age of directors and firm profitability.
2.7 Executive board composition
In recent years a lot of research has been done on the influence of top management on firm performances. In the 1990s most of this research was focused on the direct link between demographic characteristics of top managers and firm performance (Bantel, 1993; Michel & Hambrick, 1992; Wierseman & Bantel, 1992). However, this demographic approach was criticized and it was stated that the link between these entities is more complex and indirect. Researchers shifted their attention more to the linkages between demographic characteristics, decision-making processes and firm performance. The framework from Forbes and Milliken (1999) that is earlier described in the supervisory board section can also be applied on the effectiveness of the executive board. However, the effectiveness of both boards rely on different task performances.
Top managers are hired by principals and are therefore the foundation of the agency theory and stewardship theory that are mentioned before. Executive directors can be seen as the daily operating top managers of a professional football club. These directors make operational and strategic decisions and have an overall responsibility for managing the organization. The main task of executive directors is managing the firm and in this particular cases the professional football club. Therefore, it is important that these directors possess good management skills. The following section will demystify the influences of demographic characteristics on the effectiveness of executive boards and firm performance.
2.7.1 Board size
Board size is not so much a demographical attribute like as mentioned earlier, but all the more a very important and much studied board characteristic that can have a significant influence on executive board processes. Therefore, it can also be stated that this attribute is very closely related to the demography of the executive board.
Large boards are better than smaller ones because large teams have more sophisticated capabilities and resources to solve problems and tasks (Jackson, 1992). A large management team will come up with more information, solve more problems and create strategies from more different points of view. This results in an increase in cognitive conflicts and an increase in the use of knowledge and will both result in higher-quality decisions (Cummings et al., 1974; Ziller, 1957). From the latter mentioned facts, it is safe to conclude that, from a resource based and stewardship view, larger executive boards are associated with better firm performances. Hambrick and D’Aveni (1992) e.g.
found that firms facing bankruptcy tended to have smaller top management teams than comparable surviving firms.
However, large groups have also some disadvantages because these tend to create distortion in coordination and communication within the executive board (Shaw & Harkey, 1976; Blau, 1970). Smaller executive boards are more cohesive and will reach consensus faster and can also make faster decisions (Shull et al., 1970; Shaw, 1981; Swap, 1984). Increased quality in communication, coordination and cohesiveness can lead to better task performances of the executive board and will therefore increase firm performances.
2.7.2 Board tenure
The definition of board tenure covers the number of years that an individual board member has served in the executive board of a professional football club. The theory about board tenure contains conflicting views that will be discussed hereafter.
Board members who serve the executive board for a significantly longer time will improve the effectiveness of the top management. Katz (1982) suggests that increased tenure is associated with reduced conflict, stability and superior communication. Longer tenure on the executive board is also associated with social cohesion and shared cognitive structures (Michel & Hambrick, 1992). So, the theory about increased tenure is mostly focused on collaboration between the members within the board. Due to a longer tenure the board members will develop a better understanding of interrelated board interaction and will reach consensus more easily. Therefore, it can be stated that increased executive board tenure may enhance socialization and lead to better firm performance (Carroll & Harrison, 1998; Smith et al. 1994).
However, executive increased board tenure may also be associated with some disadvantages (Keck, 1997). Increased socialization, mentioned from above, can result in dysfunctional decision-making processes. Because these directors have served for a long time in the executive board, they will rely on decisions which have turned out successful in the past and they will not think outside-of-the-box. Executive board members may tend to develop similar views which can result into a corporate paradigm (Pfeffer, 1983). This process is also called “group thinking”, a collective pattern of defensive avoidance (Janis & Mann, 1977; Keck, 1997). From this point of view it can be stated that new executive team members can bring some new insights to the table of the conference room. This will increase cognitive conflict and will therefore increase the task performances of the executive board. Eventually, this suggests that short tenure may lead to better firm performances.
2.7.3 Director age
Age is an important demographic element for the composition of the executive board. Age, from a classic point of view, is always related to experience and knowledge. Older managers have a greater stake in supporting the status quo and will therefore continue the strategies they adopted over the past years (Hambrick & Mason, 1984). Older executives are furthermore associated with risk-avoiding
behavior, because they may be at a stage in their careers where financial security is very important (Wierseman & Bantel, 1992). They avoid risk-taking behavior to secure the stability of a firm. From the resource dependency and stewardship theory can be stated that older executive board members will provide more knowledge and skills and therefore will increase firm performance (Cochran et al., 1984; Rose, 2005).
However, risk-taking by managers can provide new opportunities which may increase firm performance. Some researchers suggest that young managers are associated with greater strategic change and older managers may be less willing to adapt to new behaviors or ideas (Wiersema & Bantel, 1992; Bantel & Jackson, 1989). Young managers will increase the cognitive conflict and will therefore increase task performances of the executive board and firm performance.
2.8 Board diversity
The theory behind board diversity is generally applicable for supervisory and executive boards and rests upon the main premises of diversity.
Team diversity based on age, tenure, education and functional background can play an important role in the strategic decision-making process (Tihanyi et al., 2000). Age heterogeneity within a team can have influence on shaping executives’ attitudes and beliefs (Bantel & Jackson, 1989). Tihanyi et al. (2000) stated that age diversity is able to encourage the exchange of a wide variety of perspectives. The rationale concerning the diversity of age may also apply to heterogeneity of tenure on the executive directors’ and supervisory board. Teams featuring tenure heterogeneity or age heterogeneity may reflect higher levels of conflict and will be more effective. These two types of diversification are especially important in a dynamic environment like the professional football industry. However, age and tenure diversification can also be a cause for even worse communication within the board and will therefore reduce the performances of the board members. In addition, education background and work experiences influences executive’s cognitive base and strategic decision making processes and outcomes (Hitt & Tyler, 1991; Bantel & Jackson, 1989). Finkelstein (1992) suggests that top management teams with a broader functional background will be able to deal better with complex problems. The last decade has been of an emancipator character, as women were also much more explicitly present in the professional football industry which has been predominantly ruled by men. Adding women to boards of the football clubs will increase diversity of the board and can thereby increase different resources and perspectives which can be beneficial for the organization (Hillman et al. 2007).
Taking all of this in consideration, it can be stated that executive and supervisory boards with greater diversity of age, tenure, education or functional background may possess a more diverse set of values, experiences and beliefs (Tihanyi et al., 2000). Diversity within a board can provide some more perspectives, opinions and experiences that can lead to a better decision-making process (Adams & Ferreira, 2008). This can reduce the ‘group thinking problem’ because they will not use the most
