The Labor Market for Directors and Externalities in Corporate Governance

Abstract

This paper studies how directors' reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms' governance, and governance in turn affects firms' demand for new directors. Whether the labor market rewards a shareholder‐friendly or management‐friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors' desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors' reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence.

Under the microscope: An experimental look at board transparency and director monitoring behavior

“…We contribute to this literature by relaxing the assumption of information asymmetry that is so prevalent in principal–agent models, and by exploring whether transparency weakens or amplifies the effects of these different director interests on director monitoring behavior. Levit and Malenko () proposed in their theoretical model that increasing boardroom transparency might amplify a macro‐governance system's characteristics. That is, “improving boardroom transparency is likely to strengthen corporate governance if aggregate governance is already strong, but is likely to weaken governance further if aggregate governance is already weak” (Levit & Malenko, , p. 778).…”

“…Levit and Malenko () proposed in their theoretical model that increasing boardroom transparency might amplify a macro‐governance system's characteristics. That is, “improving boardroom transparency is likely to strengthen corporate governance if aggregate governance is already strong, but is likely to weaken governance further if aggregate governance is already weak” (Levit & Malenko, , p. 778). Our study complements and extends Levit and Malenko's conceptual proposition by theorizing and empirically demonstrating how increasing boardroom transparency changes board monitoring at the individual director level.…”

Executive incentive compatibility and selection of governance mechanisms

“…This study is also connected to a large literature of strategic selection of corporate governance such as Levit and Malenko (), Acharya et al . (), Dicks (), Fahlenbrach (), Ward et al .…”

“…() and Cremers and Nair () among others. In Levit and Malenko (), firms may strategically select stronger or weaker governance due to the influence of directors’ reputational concerns, while in Acharya et al . () and Dicks (), stricter governance standards are considered a substitute for pay for performance.…”

“…The above three papers focus on the interaction between firms’ choices of corporate governance, that is governance externalities. While in our simple model setup, only individual firm selection of governance mechanism is studied, which could be seen as a complementary study to the comparatively more sophisticated models in Levit and Malenko (), Acharya et al . () and Dicks ().…”