Independent Directors and Corporate Litigation

Abstract

In this paper, we examine the effects of board structure on a wide variety of corporate litigation. We use a unique hand-collected dataset of corporate lawsuits and the 2002 NYSE/NASDAQ exchange listing requirements, as an exogenous shock to board independence, to empirically examine the monitoring effectiveness of board independence using a difference-in-differences framework. We find that an increase in board independence is associated with a significant reduction in multiple types of corporate litigation, beyond securities lawsuits. This evidence is consistent with stronger monitoring by independent directors. However, we also find evidence that greater board independence can inhibit a board’s ability to monitor internal actions or favor shareholders over other stakeholders. Specifically, mandatory increases in board independence, which reduces a board’s knowledge of firm-specific information, makes a firm more susceptible to product liability, and labor litigation. Furthermore, in firms with higher debt levels, increasing board independence, with the intent to increase shareholder representation, is associated with an increase in financially related litigation. The evidence is consistent with the generally greater monitoring provided by independent directors, but it also reveals limitations to their monitoring as well as their reduced concern for other stakeholders. Finally, we find evidence that the appointment of female independent directors is one mechanism through which independent directors reduce litigation.

Keywords: Independent directors; Inside directors; Corporate litigation

JEL Classification: G30