Independent Directors and Corporate Litigation

Abstract

In this paper, we examine the effects of board structure on a wide variety of corporate litigation. We use a unique hand-collected dataset of corporate law suits and the 2002 NYSE/NASDAQ exchange listing requirements, as an exogenous shock to board independence, to empirically examine the monitoring effectiveness of board independence using a difference-in-difference framework. We find that an increase in board independence is associated with a significant reduction in multiple types of corporate litigation, beyond shareholder class action lawsuits. While this evidence is consistent with stronger monitoring by independent directors we also find evidence that greater board independence can inhibit a board’s ability to monitor internal actions. Specifically, we find evidence that mandatory increases in board independence, which reduces a board’s knowledge of firm-specific information, can make a firm more susceptible to product liability, employment and labor litigation. The evidence is consistent with the greater monitoring role independent directors provide, but also their limitations when it comes to monitoring in firms where firm-specific information is more important.