Is Company Performance Dependent on Outside Director 'Skin in the Game'?
36 Pages Posted: 25 Jan 2011
Date Written: November 26, 2010
Whilst researchers extensively investigate executive incentives, very little appears in the literature on the effect of outside-director ‘skin in the game’ on board monitoring and thus firm performance. Utilizing a unique panel dataset, we observe a sizeable positive relationship between non-executive director ownership and firm performance. Companies with just one standard deviation greater non-executive director ownership, perform 28.2% better than the mean, as measured by Tobin’s Q. We also show that the effectiveness of monitoring improves as one reduces both board size and the proportion of outside directors. Greater skin in the game possessed by executive board members also improves firm performance over most but not all ownership ranges. We subject our results to a powerful event study: do investors recognize that outside and inside director skin in the game protects investors during a calamity, namely the Global Financial Crisis (GFC)? Yes, the relative stock price decline is far less for incentivized boards during the GFC, consistent with the panel data results utilizing Tobin’s Q. These results during a calamitous period have the added advantage of casting doubt on the reverse causality argument: directors of better performing firms have sufficient foresight to choose to hold more equity.
Keywords: Board monitoring, Incentive alignment, Independent director, Executive director, Firm performance
JEL Classification: G34, J41, J44, L25
Suggested Citation: Suggested Citation