NBER Working Paper
What makes a good monitor? Embodied in some regulatory requirements is the notion that independent directors provide a particular type of objective, shareholder-minded oversight. At the same time, little is known about the characteristics of independent directors, or the factors that influence the selection process of these directors.
In this paper we exploit a unique, hand-collected database of independent directors to test the hypothesis that boards appoint directors who, while technically independent according to regulatory definitions, nonetheless may be overly sympathetic to management. To do so, we investigate a subset of independent directors — analysts who covered the company — for whom we have detailed, micro-level data on their views regarding the firm prior to being appointed to the board.
We use these data to compare the roles of optimism versus skill in the board-appointment process. Focusing on ex-ante, observable characteristics of the independent directors themselves allows us to directly evaluate the objectivity and potential efficacy of independent directors based solely on their actual opinions about the firm in question.
We find that board-appointed analysts issue significantly more positive recommendations on companies that subsequently appoint them to the board; both relative to the other stocks they cover, and relative to other analysts covering these same stocks.
Additionally, board-appointed analysts demonstrate inferiority overall, both for earnings forecasts and for stock recommendations, not only for the companies that later invite them to join their boards but across the entire portfolio of stocks they cover.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees.
This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.