Playing Favorites? Industry Expert Directors in Diversified Firms

Abstract

We examine the influence of outside directors’ industry experience on segment investment, segment operating performance, and firm valuation for conglomerates. Given board composition is endogenous, we instrument for the presence of industry expert directors using the supply of experienced executives near conglomerate firms’ headquarters. We find that industry expert representation on the board causes increased segment investment. Consistent with experienced directors playing favorites rather than acting as dispassionate advisors, segment profitability (firm value) is lower for segments (firms) with industry expert outside directors. We do not find analogous negative profitability or valuation effects of director experience for single-segment firms.

Keywords: Director experience, corporate diversification, investment

JEL Classification: G34, G31