Don't Judge a Book by Its Cover: The Influence of Independent Directors’ Busyness and Tenure on Earnings Quality

Abstract

In this paper we argue and empirically find that factual rather than “cosmetic” independence has a differential impact on board effectiveness with reference to the quality of financial reporting. We first shed light on past conflicting findings by showing a curvilinear relation between two important independent directors’ characteristics, busyness and tenure, and levels of earnings management. By adopting an interaction perspective, we then show that independent directors’ ability to constrain earnings management is strongly impaired by their length of tenure, and it fades away entirely when independent directors are “too busy”. We also look at independent directors sitting on Audit Committees and we get identical results. This work comes in response to recent calls for more work on how independent directors’ effectiveness is impacted by directors’ attributes and shows that a co-alignment of several attributes is needed, rather than just the application of the convenient “independence” label.

Keywords: Busyness, Tenure, Earnings Management, Independent Directors