The Labor Market for Directors and Externalities in Corporate Governance

Abstract:     
This paper studies how directors' reputational concerns in the labor market affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance, in turn, affects firms' demand for new directors. Whether the labor market rewards a shareholder-friendly or management-friendly reputation is thus endogenous and depends on the aggregate quality of corporate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of governance across firms. As a result, an equilibrium with strong aggregate governance can co-exist with a weak governance equilibrium, suggesting that countries or industries with similar characteristics can have very different governance systems. We also show that directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for regulations restricting multiple directorships, boardroom transparency, shareholder activism, and board size.

Number of Pages in PDF File: 50

Keywords: board of directors, corporate governance, reputation, externalities, strategic complementarity, transparency

JEL Classification: D62, D71, D82, D83, G34, G38, J20

working papers series