Since before the Sarbanes-Oxley Act, regulators have been pushing for independent directors as a solution to various corporate governance problems. But how effective are they? This important paper sheds some light on the issue.
In this paper, we examine the circumstances under which so-called “independent” directors voice their independent views on public boards in a sample of Chinese firms. First, we ask why independent directors dissent, i.e. how they justify such dissent to public investors. We find that when independent directors dissent, they tend to offer mild, subjective justifications. Overt criticism of the management is rare. Next, we ask when an independent director is more likely to dissent and who is more likely to dissent. Controlling for firm and board characteristics, we find that dissent is significantly correlated with breakdown of social ties between the independent director and the board chair who locates at the center of the board bureaucracy in China. Dissent is more likely to occur when the board chair who appointed the independent director has left the board. Dissent also tends to occur at the end of board “games”, defined as a 60-day window prior to departure of the board chair or departure of the independent director herself. The endgame effect is particularly strong, seeing 27% of the dissent issued at board “endgames” which represents only 4% of independent directors’ average tenure. While directors with foreign experience are more likely to dissent, we do not find that academics, accountants and lawyers are significantly more active in voicing dissent. Lastly, we show that dissent is consequential to both the director and the firm. For directors, dissent significantly increases one’s likelihood of exiting the director labor market, which translates to a more-than-10% estimated loss of annual income. For firms, we document an economically and statistically significant cumulative abnormal return of -0.97% around announcement of dissent. Although the literature has suggested that dissent might be reflective of diverse viewpoints, and perhaps beneficial in and of itself through reduction of firm variability, we do not find this offsetting beneficial effect to be strong.
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