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Industry Expertise of Independent Directors and Board Monitoring

74 Pages Posted: 11 Mar 2013 Last revised: 19 Jan 2017

Cong Wang

China Europe International Business School (CEIBS)

Fei Xie

University of Delaware

Min Zhu

City University of Hong Kong (CityUHK); World Bank - Development Research Group; University of Michigan, Stephen M. Ross School of Business

Date Written: October 2015

Abstract

Does industry experience affect the monitoring effectiveness of independent directors? On the one hand, prior industry experience provides independent directors industry-specific knowledge and expertise critical for understanding and evaluating managerial decision making, thereby enhancing their monitoring capability. On the other hand, independent directors with prior experience in the firm’s industry may be socially connected with or sympathetic to the firm’s management, thus impairing their monitoring incentives. We test these competing hypotheses in a variety of firm polices and decision making. Specifically, we find that the presence of independent directors with industry experience on a firm’s audit committee significantly curtails firms’ earnings management via abnormal accruals and reduces both ex ante and ex post probabilities of firms committing financial fraud. In addition, a greater representation of independent directors with industry expertise on a firm’s compensation committee reduces CEO excess compensation and a greater presence of such directors on the full board increases the CEO turnover-performance sensitivity and improves acquirer returns from diversifying acquisitions. Overall, the evidence is the consistent with the hypothesis that having relevant industry expertise enhances independent directors’ ability to perform their monitoring function. As such, our study sheds new light on the determinants of board effectiveness and provides important policy implications for the design of corporate boards.

Suggested Citation

Wang, Cong and Xie, Fei and Zhu, Min, Industry Expertise of Independent Directors and Board Monitoring (October 2015). Journal of Financial and Quantitative Analysis, Vol. 50, Issue 5, pp. 929-962. Available at SSRN: https://ssrn.com/abstract=2230911 or http://dx.doi.org/10.2139/ssrn.2230911

Cong Wang

China Europe International Business School (CEIBS) ( email )

Shanghai-Hongfeng Road
Shanghai 201206
Shanghai 201206
China

Fei Xie (Contact Author)

University of Delaware ( email )

Newark, DE 19711
United States

Min Zhu

City University of Hong Kong (CityUHK)

83 Tat Chee Avenue
Kowloon
Hong Kong
China

World Bank - Development Research Group

1818 H Street NW
Washington, DC DC 20433
United States

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI 48109
United States

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