Capital Structure

Topics: Corporate governance, Board of directors, Corporate title Pages: 78 (22417 words) Published: August 18, 2013
The Supply of Corporate Directors and Board Independence
Anzhela Knyazeva Simon School of Business, University of Rochester Diana Knyazeva Simon School of Business, University of Rochester Downloaded from http://rfs.oxfordjournals.org/ at Bharatidasan University on August 16, 2013

Ronald W. Masulis Australian School of Business, University of New South Wales Empirical evidence on the relations between board independence and board decisions and firm performance is generally confounded by serious endogeneity issues. We circumvent these endogeneity problems by demonstrating the strong impact of the local director labor market on board composition. Specifically, we show that proximity to larger pools of local director talent leads to more independent boards for all but the largest quartile of S&P 1500. Using local director pools as an instrument for board independence, we document that board independence has a positive effect on firm value, operating performance, fraction of CEO incentive-based pay, and CEO turnover. (JEL G30, G34)

Prior research has emphasized the role of the board of directors in monitoring and advising the CEO and the importance of board composition (e.g., Adams and Ferreira 2007; Fama and Jensen 1983; Weisbach 1988). However, in spite of extensive work on the subject of board independence and shareholder value (see, e.g., Coles, Daniel, and Naveen 2008 for a survey of prior literature), the empirical evidence on the effects of board independence on major board decisions and firm performance is often contradictory or lacking in significance. This mixed evidence is in large part attributable to endogeneity issues that arise in the choice of corporate governance mechanisms. For valuable comments, we are indebted to the editor (Michael Weisbach), an anonymous referee, Bernard Black, Christa Bouwman, Qianqian Du, Kose John, Jason Kotter, Rafael LaPorta, John Long, Vikram Nanda, Subrata Sarkar, George Serafeim, Cliff Smith, Jerry Warner, Toni Whited, Fei Xie, and Wanli Zhao, as well as conference and seminar participants at the 2009 European Financial Management Symposium on Corporate Governance and Control, 2009 Financial Management Association Annual Meetings, 2010 Asian Financial Management Association Meetings, 2010 Deakin Finance Colloquium, 2nd Finance and Corporate Governance Conference, Melbourne, 2010 Australasian Finance and Banking Conference, 2011 SFS Cavalcade, 2011 Frontiers of Finance Conference at ISB Hyderabad, 2012American FinanceAssociation Meetings, 2012 Financial Intermediation Research Society Meetings, and seminars at the University of Michigan, Dartmouth College, University of Queensland, and Binghamton University. This paper was previously circulated under the titles “Effects of local director markets on corporate boards” and “Local director talent and board composition.” The authors gratefully acknowledge the financial support of the Simon School of Business and the Financial Markets Research Center at Vanderbilt University. Send correspondence to Anzhela Knyazeva, Simon School of Business, University of Rochester, NY 14627; telephone: (585) 275-3102. E-mail: aknyazeva@simon.rochester.edu. © The Author 2013. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com. doi:10.1093/rfs/hht020

The Review of Financial Studies / v 26 n 6 2013

Reinforcing concerns about endogeneity, a growing body of research focuses on optimal board design and firm characteristics associated with the demand for independent director representation on boards (Boone et al. 2007; Raheja 2005, etc.) Other research has highlighted the role of private benefits of control and CEO influence over director appointments in explaining the level of board independence (e.g., Hermalin and Weisbach 1998, 2003; Shivdasani and Yermack 1999). We circumvent these endogeneity concerns by exploring the role of the local...

References: Downloaded from http://rfs.oxfordjournals.org/ at Bharatidasan University on August 16, 2013
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Perry, T., and U
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