Why do Publicly Listed Companies Appoint Board Observers?

Abstract

This study investigates the motivations behind board observer appointments in large publicly listed firms. Board observers are as informed as regular board members and can act in an advisory capacity but have no voting rights, fiduciary duties, or carry legal liability. We theorize that the board observer role has emerged as a response to constraints in board optimization, including limited director supply, governance regulation and director replacement costs. We show empirically that, due to their unregulated nature, board observer appointments are widely used to circumvent corporate governance regulation. However, we also find that the board observer role facilitates director succession and provides firms with advisory capacity.

Keywords: Board Observers, Board Composition, Director Succession, Regulatory Circumvention, Director Supply