Board Connectedness and Board Effectiveness

Abstract

We examine the effect of the social connectedness of independent, non-co-opted directors on their ability to monitor and advise the firm. We begin by providing evidence that well-connected directors have greater protection from career concerns. We next examine the channels by which director connectedness may improve monitoring and find that audit committee connectedness has a positive effect on the quality of financial reporting. Further, better connected compensation committees are less likely to overpay the CEO. Finally, we examine the effect of well-connected directors on the firm’s information environment. We show that firms with highly connected boards have lower financing costs and higher payout ratios. We also find that better connected boards are better able to shield the firm from the negative impact of a competition shock. Our results are robust to multiple approaches to mitigate endogeneity. Overall, well-connected boards appear to be effective in promoting shareholders’ interests.

Keywords: Centrality; Board connectedness; Board effectiveness; Fraud; Compensation; SEOs

JEL Classification: G30; J33; M52