How do Corporate Boards Balance Monitoring and Advising? The Situational Use of Special Committees in Corporate Takeovers

Abstract

This paper extends the literature on corporate governance by analyzing the voluntary use of special committees during corporate takeovers. These committees are comprised of disinterested target firm directors and serve as an additional mechanism to enhance the oversight of potential conflicts. Our sample spans post Sarbanes-Oxley from 2003 through 2007, under which boards of directors are subject to increased scrutiny and additional regulatory mandates. This period is also characterized by a high level of buyout activity that can exacerbate conflicts. Our results show that special committee use is positively related conflicts and negatively related to factors and situations where insider knowledge is particularly valuable. Moreover, the propensity to form a committee is negatively related to the board’s overall independence; hence special committees substitute for the monitoring not found in the overall board composition. Special committees, on average, are formed well in advance of the merger agreement, employ additional financial advisors, and are more likely to run an auction process. Collectively, they provide the ability of boards to adapt to situational conflicts, which may help explain when independent directors matter for corporate governance.

Keywords: Acquisitions, Mergers, Board of Directors, Agency Problems, Conflicts

JEL Classification: G34, K22