We investigate the potential costs and benefits of firms constituting a heterogeneous pool of directors relative to more homogeneous boards. We measure director heterogeneity along six separate dimensions and divide board heterogeneity into occupational and social components. Our empirical analysis indicates that corporate complexity and managerial control exhibit significant influence on board heterogeneity. Using the heterogeneity of the county population of the firm's headquarters as an instrument, we also find that investors place valuation premiums on heterogeneous boards in complex firms but discount heterogeneity in less complex firms. Overall, our analysis indicates greater heterogeneity may not necessarily improve board efficacy.
Recent trends in corporate board composition indicate an increase in the appointment of directors with legal expertise. Using two financial reporting quality measures, accruals quality and discretionary accruals, we find—for a sample of Russell 1000 firms in 2003 and 2005—that the presence (and proportion) of directors with legal backgrounds on the audit committee is associated with higher financial reporting quality. These results obtain after controlling for accounting expertise on audit committees. Also, supplementary tests indicate a positive association between changes in legal expertise and changes in financial reporting quality, suggesting that legal expertise serves as a monitor rather than as a signal of financial reporting quality. Further, the two forms of expertise interact —i.e., the presence of directors with both forms of expertise enhances financial reporting quality, beyond the contribution of the individual forms of expertise. Additional tests suggest that the positive effects of legal expertise are greater in the post-SOX period compared with a pre-SOX year.
We investigate the relation between organization structure and the information content of short sales, focusing on founder-and heir-controlled firms. Our analysis indicates that family-controlled firms experience substantially higher abnormal short sales prior to negative earnings shocks than nonfamily firms. Supplementary testing indicates that family control characteristics intensify informed short selling. Further analysis suggests that daily short-sale interest in family firms contains useful information in forecasting stock returns; however, we find no discernable effect for nonfamily firms. This analysis provides compelling evidence that informed trading via short sales occurs more readily in family firms than in nonfamily firms.CRITICS OBSERVE THAT SHORT sales allow traders to bet on a company's demise. 1 Academic research suggests that short-sale activity anticipates poor firm performance and often reflects interest by informed traders with negative, nonpublic information on the firm (Diamond and Verrecchia (1987), Asquith, Pathak, and Ritter (2005)). Building on this influential literature, we examine how organization structure can influence the potential for informed trading. Our analysis focuses on short-sale activity in a specific organizational structure, founding family-controlled firms. Pérez-González (2006) notes the pervasiveness and prominence of family ownership in publicly traded U.S. firms while Shleifer and Vishny (1986) report that families control about one-third of Fortune 500 firms. Prior literature generally indicates that these controlling families are well-informed shareholders. and James (2006), for instance, argue that the family's long-standing knowledge and information base can provide benefits to outside shareholders by facilitating firm monitoring and corporate interactions with capital markets. Consistent with the notion that family owners possess superior information, Demsetz (1986) and Chan, Chen, and Hilary (2010) report that family CEOs earn greater profits on their stock trades than CEOs of nonfamily firms.
We examine a specific channel through which director connectedness may improve monitoring: financial reporting quality. We find that the connectedness of independent, non-co-opted audit committee members has a positive effect on financial reporting quality and accounting conservatism. The effect is not significant for non-audit committee or co-opted audit committee members. Our results are robust to tests designed to mitigate self-selection. Consistent with connected directors being valuable, the market reacts more negatively to the deaths of highly connected directors than to the deaths of less connected directors. Better connected directors also have better career prospects, suggesting they have greater incentives to monitor.
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