The Monitoring and Advisory Functions of Corporate Boards: Theory and Evidence
Links to Fileshttp://ssrn.com/abstract=1327066
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Type of Work58 pages
Citation of Original PublicationChen, Dong, The Monitoring and Advisory Functions of Corporate Boards: Theory and Evidence (August 1, 2008).
I develop and test a model of the two primary functions of the board of directors of a public corporation: monitoring and advising management. The model shows that higher advising intensity is associated with lower monitoring quality and higher agency costs. To test the model, I use the number of independent directors who are at the same time executive board members of other corporations as an empirical proxy for the board’s advising intensity. I test and find evidence for the validity of this empirical proxy, by contrasting the corporate policies independent executives (IEs) choose for their own firms with those they advocate as outside directors. Consistent with the predictions of the model, I find that IEs are associated with proxies for higher agency costs. I also find that IEs are positively, significantly, and causally associated with firm performance. Finally, I argue that the significant relation between IEs and firm performance is due to the scarcity of IEs, and use the passage of Sarbanes-Oxley Act as a natural experiment to demonstrate the validity of this argument.