When Are Outside Directors Effective?

61 Pages Posted: 26 Mar 2008 Last revised: 13 Nov 2013

See all articles by Ran Duchin

Ran Duchin

Boston College - Carroll School of Management

John G. Matsusaka

University of Southern California - Marshall School of Business; USC Gould School of Law

Oguzhan Ozbas

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: September 28, 2009

Abstract

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.

JEL Classification: D23, G34, K22

Suggested Citation

Duchin, Ran and Matsusaka, John G. and Ozbas, Oguzhan, When Are Outside Directors Effective? (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, Available at SSRN: https://ssrn.com/abstract=1026488

Ran Duchin

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

John G. Matsusaka

University of Southern California - Marshall School of Business ( email )

Department of Finance & Business Economics
Los Angeles, CA 90089
United States
213-740-6495 (Phone)
213-740-6650 (Fax)

USC Gould School of Law

699 Exposition Boulevard
Los Angeles, CA 90089
United States
213-740-6495 (Phone)

Oguzhan Ozbas (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-0781 (Phone)
213-740-6650 (Fax)

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