The Economics of Independent Director Exit and Voice
64 Pages Posted: 12 Aug 2022 Last revised: 30 Oct 2023
Date Written: May 22, 2022
We jointly examine the economic determinants of directors’ exit and dissent decisions using the enactment of China’s New Securities Law (NSL) as a laboratory. NSL substantially raises monetary penalties for failing to detect financial misreporting, and our findings suggest that directors’ decisions are informative about misreporting risk. We show that NSL leads to more frequent resignations, particularly in firms that have a higher ex-ante likelihood of financial misreporting and among directors with greater reputational concerns. We find that dissensions on proposals involving financial reporting issues frequently precede resignations, suggesting that voice and exit are complementary signals of misreporting risk. Stock prices react negatively to director resignations and the effect is stronger among firms with higher misreporting risk. We also find that post NSL, replacement directors have characteristics consistent with lower monitoring ability. Ostensibly to alleviate this unintended consequence, three times as many firms purchase Directors and Officers (D&O) insurance post NSL despite significantly higher premia, and two years after the NSL passes, new regulation that exempts independent directors from penalties under various circumstances.
Keywords: independent director resignations, director dissensions, D&O insurance
JEL Classification: G31, G32, G34, M40.
Suggested Citation: Suggested Citation