Directors Skill and Financial Reporting Quality

Abstract

Motivated by theoretical models in economics which show that there is matching between CEO skill and firm size, we introduce a new measure of director skill which is based on the aggregate size of firms on which the director serves as an independent director. We validate our measure by showing that it is positively associated with director experience, financial expertise, industry expertise, and managerial experience. We then examine whether our average measure of skill across board members is positively associated with monitoring quality. Controlling for the endogenous relation between board composition and financial reporting quality, we find a positive association between our board measure for skill and monitoring quality, and we show that directors have a causal impact on monitoring effort and outcomes. Furthermore, consistent with the enhanced monitoring provided by skilled directors, we document a positive association between the level of and changes in our measure and firm value.

Keywords: Independent Directors; Financial Reporting Quality; Monitoring; Skill

JEL Classification: G34, M41