Does Monitoring by Independent Directors Reduce Firm Risk?
47 Pages Posted: 17 Jan 2012 Last revised: 1 May 2012
Date Written: March 25, 2012
Abstract
We ask whether an increase in the proportion of independent directors on a firm’s board leads to more conservative operating decisions and whether the cumulative effect of these decisions is to reduce stock-based measures of company risk. We find support for both hypotheses and provide evidence that on the operating side, investment rates are lower, return on assets is less variable, growth opportunities are reduced, and the firm is less likely to make acquisitions as the proportion of independent directors increases. Consistent with conservative operating decisions, we also find reduced risk in the company’s stock returns for firms with a greater proportion of independent directors. Idiosyncratic risk is lower and stock returns have less negative skewness, implying a lower risk of stock price crash. Our results hold under various robustness tests including the use of alternative measures of risk and incorporating controls for other board and firm characteristics that may influence the effectiveness of directors in monitoring firm management. Our findings may help to explain the failure of researchers to find evidence that independent directors enhance firm performance since conservative decisions may result in missed opportunities for risky but potentially large gains.
Keywords: board independence, idiosyncratic risk, operating risk
JEL Classification: G32, G34
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Creditor Rights and Corporate Risk-Taking
By Viral V. Acharya, Yakov Amihud, ...
-
Access to Collateral and Corporate Debt Structure: Evidence from a Natural Experiment
By Vikrant Vig
-
Growing Out of Trouble? Corporate Responses to Liability Risk
By Todd A. Gormley and David A. Matsa
-
Bank Finance Versus Bond Finance
By Fiorella De Fiore and Harald Uhlig