Executives’ Connections to Directors and Internal Governance

Abstract

Outside directors’ monitoring effectiveness is curtailed by information asymmetry between boards and management. Connections between independent directors and non-CEO executives may overcome this challenge by facilitating information sharing between the connected parties. Such connections can also empower executives to withstand pressure from CEOs to take actions undermining executives’ performance in their functional areas. Indeed, we find that earnings restatements, class-action litigations, and real earnings management decrease when directors are connected with executives responsible for these areas. Overall, findings show that director–executive ties are associated with stronger internal governance, suggesting that boards may benefit from forging stronger relationships with executives.