Role of Outside Directors in Firm Monitoring

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There is much debate about the role of outside directors as effective monitors of the firm. Two early studies that address this issue are Fama (1980) and Fama and Jensen (1983). Fama (1980) in their seminal work show that board of directors can be efficient monitors of an organization. Fama and Jensen (1983) argue that outside directors have the incentives to develop reputation and signal the markets as efficient monitors of the firm . The crux of the argument on outside directors are whether the outside directors, support the shareholders or are likely to be aligned with the interests of the management. Studies such as Mace (1986), Patton and Baker (1987), and Jensen (1993) argue that since top management can influence the appointment of an …show more content…

Also in an event study the authors show that firms announcing the appointment of multiple directors for the first time experience higher abnormal returns. Beasley (1996) finds that firms whose outside directors hold more board seats are less likely to commit fraud because inclusion of outside members on the board of director increases the board 's effectiveness at monitoring management for the prevention of financial statement fraud. Cotter, Shivdasani, and Zenner (1997) examine the role played by independent outside director during tender offers and they report that target firm with independent boards commands higher merger premium, because the authors find that target shareholder gains are higher in resisted offers also having majority outside directors. Similarly, Brown and Maloney (1999) find higher acquirer returns when directors with multiple board seats serve on the acquirer’s board. These studies all provide ample evidence that outside director has avital role not only in the corporate governance of the firm but also are beneficial for firm …show more content…

The Council of Institutional Investors (1998) documents that full-time directors should not serve on more than two other boards. The National Association of Corporate Directors (1996) suggests that full-time directors should not serve on more than three or four other boards. In contrast The Principles of Corporate Governance issued by The Business Roundtable (1997) believes that limits on the number of directorships are not required. Further a survey of directors of Fortune 500 companies by Korn/Ferry International (1998) shows that too many board appointments place an excessive burden on a director. Fifty-six percent of outside directors report that they declined an invitation to serve on an additional board, sharing the view that it is not feasible to serve too many boards. Because the directors in the survey believed that too many board appointments might distract them, thereby making them inefficient monitors. There is ample evidence that suggest the US market has efficient infrastructure and established institutions that has well-functioning capital, labor and product markets. The transaction cost theory proposed by Coase (1937) and Williamson (1985) suggests that the optimal structure of a firm depends on its institutional context . However, in emerging market

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