A review of Masulis, R. W. and E. J. Zhang, 2019, “How Valuable Are Independent Directors? Evidence from External Distractions,” Journal of Financial Economics 132, 226-256.
I. Research question and its importance
Continuing the work of Hermalin and Weisbach (2003) and the literature of board independence, this article proposes a new identification of independent director effect via a common economic phenomenon, director distraction, which is exogenous to firm performance. Because prior empirical result for independent director was mixed, the authors contribute to this literature by delving into director level and separating independent and affiliate directors. The authors investigate the effect of distraction on three director-level outcomes (i.e., board meeting attendance, trading frequency of firm stock, and turnover within two years) as well as four firm-level outcomes (i.e., performance and value, operating efficiency, acquisition return, and accounting quality).
II. Method and finding
The observation covers S&P 1500 firms from 2000 to 2013. In a quasi-experimental setting, propensity score matching was employed to construct a control group. The treatment is director distraction (cf. Holmstrom and Milgrom, 1991). Linear probability model, OLS, and other sophisticating specifications were used. For robustness checks, the authors also examine spillover effect (cf. Falato et al., 2014), macrolevel shock (e.g., by testing events separately) and employ difference-in-differences to deal with potential endogeneity issue. Ultimately, they show that independent directors are valuable firm monitors and advisors, especially when they play key board roles or have critical expertise.
III. Limitation and future research
This work showcases more hardworking than innovation. In other words, the results (e.g., board independence creates value) are not surprising in a general sense. Although the authors discuss a broad array of outcomes, they did not provide good rationale for each of them. For example, under what condition does board independence affect M&A performance remains unexplained in (although not the purpose of) this article. Future work might provide in-depth investigation for the proposition presented by this work and rule out the unique alternative explanations for each of them, e.g., board independence might decrease agency problem and hence increase the value creation of M&A, but at the same time might hinder management due to conservatism and shareholder protection. Furthermore, to establish credible causal inference for each unique outcome covered by this paper, rigorous research design is essential. Taking the example of M&A, a credible inference requires control group of firms with similar probability in experiencing M&A but not suffering from distracted director.
Finally, this article attempts to converse with a wide range of literature by scoping diverse firm level outcome. Despite that they manage to present consistent results, the story is not coherent. Future work might improve the rationale connecting independent director and M&A profitability as well as operating performance. Then, a research design ruling out outcome-specific alternative explanations can be devised, and credible inference could hold.