When Are Outside Directors Effective?
University of Washington - Michael G. Foster School of Business
John G. Matsusaka
University of Southern California - Marshall School of Business; USC Gould School of Law
University of Southern California - Marshall School of Business - Finance and Business Economics Department
September 28, 2009
Journal of Financial Economics (JFE), Forthcoming
USC CLEO Research Paper No. C07-13
Marshall School of Business Working Paper No. MKT 02-09
This paper uses recent regulations that have required some companies to increase the number of outside directors on their boards to generate estimates of the effect of board independence on performance that are largely free from endogeneity problems. Our main finding is that the effectiveness of outside directors depends on the cost of acquiring information about the firm: when the cost of acquiring information is low, performance increases when outsiders are added to the board, and when the cost of information is high, performance worsens when outsiders are added to the board. The estimates provide some of the cleanest estimates to date that board independence matters, and the finding that board effectiveness depends on information cost supports a nascent theoretical literature emphasizing information asymmetry. We also find that firms compose their boards as if they understand that outsider effectiveness varies with information costs.
Number of Pages in PDF File: 61
JEL Classification: D23, G34, K22
Date posted: March 26, 2008 ; Last revised: November 13, 2013