Gray Directors and Board (Non-)Independence

Abstract

This paper studies an informational role of a decision to appoint a black director (BD) to a white board in a regime shaped by the Sarbanes-Oxley Act. I find that the decision slashes firm valuation, perhaps because it reveals the true color of existing white directors (WDs) are gray. A director is white if she passes independence criteria of both SEC and a proxy advisor and black if she passes only SEC's. Knowing the proxy advisor detects BDs and investors disfavor them, a manager appoints a BD only when he expects greater private benefits than a valuation loss and runs out of gray directors (GDs). Consistent with the mechanism, I find that a manager makes a board gray when he is short of GDs, and firm value plunges only when he turns a board gray; it varies little when he makes a board grayer or less gray. Moreover, investors find a WD of a gray board less valuable than of a white board when she suddenly passes away, suggesting the association is causal.