In Search of Board Independence: Former Employees, Shades of Gray and Director Classifications Revisited

61 Pages Posted: 17 Aug 2016 Last revised: 12 Jul 2019

See all articles by Joel F. Houston

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate

Jongsub Lee

University of Florida - Warrington College of Business Administration

Hongyu Shan

Fordham University - Finance Area

Date Written: November 3, 2016

Abstract

Former employee directors bring unique aspects to firm governance. While they have valuable firm-specific knowledge, their connections to current management often compromise their ability to serve as effective monitors. Consistent with this viewpoint, we find that the presence of former employee directors is associated with increased litigation risk. Our subsequent tests demonstrate that this positive relation is more pronounced when the former employee is 1) tied to current management, 2) holding critical monitoring position, and 3) replacing an outside director. We further highlight that the discretion in asserting the independence of former employee directors provides key insights into the firm’s relative reporting conservatism and its true desire for independence. Notably, we find that litigation is more likely to occur when boards aggressively classify a former employee as an independent director. Building upon these key findings, we demonstrate that measures of a board’s functioning independence should incorporate both the varying roles played by its gray directors and its decision on whether to classify former employee directors as independent or gray.

Keywords: functioning independence, former employees, gray directors, shades of gray, cooling-off period, reporting conservatism, corporate fraud, CEO turnover

JEL Classification: G28, G3, G01, K40, K41

Suggested Citation

Houston, Joel F. and Lee, Jongsub and Shan, Hongyu, In Search of Board Independence: Former Employees, Shades of Gray and Director Classifications Revisited (November 3, 2016). Available at SSRN: https://ssrn.com/abstract=2824150 or http://dx.doi.org/10.2139/ssrn.2824150

Joel F. Houston

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States

Jongsub Lee

University of Florida - Warrington College of Business Administration ( email )

Department of Finance Insurance & Real Estate
P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-273-4966 (Phone)
352-392-0301 (Fax)

Hongyu Shan (Contact Author)

Fordham University - Finance Area ( email )

33 West 60th Street
New York, NY 10023
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
249
Abstract Views
1,628
rank
134,428
PlumX Metrics