Board Independence and Default Risk
49 Pages Posted: 25 Jun 2019
Date Written: June 19, 2019
We conduct a comprehensive examination of the effect that boardroom independence has on corporate default risk. When measuring board independence using the regulatory definition or relying on director’s social ties with the CEO, we find no association with default risk. In contrast, measures of independence based on board co-option are strongly and positively associated with default risk, the incidence of bankruptcy, and technical defaults. We find that our baseline results are not driven by incentive misalignment problems, but rather are the consequence of co-opted boards facilitating poorer quality decision making due to lower engagement and work ethic among board members. We find that external oversight mechanisms, in the form of institutional investors, equity analysts, takeover susceptibility, and media coverage, discipline board members and curtail the negative externalities of co-opted boards. Overall, our study documents new evidence on the adverse effect of co-opted boards on firm default probability.
Keywords: expected default risk, board of directors, agency conflict, governance
JEL Classification: G30, G33, G34
Suggested Citation: Suggested Citation