Are Interlocked Directors Effective Monitors?

Abstract

This paper comprehensively examines whether the presence of interlocked directors on a board is associated with weak governance. For a sample of 3,566 firm-years over the 2001-2003 time period, we find that firms with lower industry-adjusted firm performance are more likely to have interlocked directors. We also find a negative stock price reaction to the announcement of director appointments that create interlocked directors. Finally, we document that the presence of interlocked directors is associated with lower than optimal pay-performance sensitivity of CEO incentive compensation and reduced sensitivity of CEO turnover to firm performance. Collectively, our results suggest that the presence of interlocked directors is indicative of weak governance and entrenched managers.

Keywords: director interlocks, performance, board monitoring, social networks

JEL Classification: G30, G14, G18