Abstract
We examine which independent directors are held accountable when investors sue firms for financial and disclosure related fraud. Investors can name independent directors as defendants in lawsuits, and they can vote against their re-election to express displeasure over the directors’ ineffectiveness at monitoring managers. In a sample of securities class-action lawsuits from 1996 to 2010, about 11% of independent directors are named as defendants. The likelihood of being named is greater for audit committee members and directors who sell stock during the class period. Named directors receive more negative recommendations from Institutional Shareholder Services (ISS), a proxy advisory firm, and significantly more negative votes from shareholders than directors in a benchmark sample. They are also more likely than other independent directors to leave sued firms. Overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.
Highlights
We examine accountability of independent directors when firms experience litigation for corporate financial fraud
We use the incidence of independent directors being named as defendants in securities class action lawsuits and shareholder votes against those directors to assess which directors are held accountable for the violations that lead to the lawsuits
We examine which independent directors shareholders hold accountable for corporate financial fraud by looking at the incidence of directors being named as defendants in shareholder litigation, shareholder voting, and director turnover
Summary
We examine whether lawsuit outcomes vary depending on whether independent directors are named as defendants. The results indicate that lawsuits that (i) allege GAAP violations, (ii) are filed under Section 11, (iii) involve an SEC action, (iv) have an institutional investor lead plaintiff, (v) are filed against larger firms, (vi) have longer class periods, and (vii) have higher share turnover during the class period have higher settlement amounts at statistically significant levels. The interactions of # Directors Named and both High Profile Lawyers and Public Lead Plaintiff exhibit a positive and significant coefficient in the settlement amount tests. Overall, these supplemental tests suggest that plaintiffs with greater negotiating power strategically name directors as defendants in lawsuits. We replace Shares Sold in all the prior tables with abnormal shares sold using the pre-class period benchmark and find no difference in the reported inferences
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