Internal Financial Expertise on the Board: Implications for Corporate Capital Structure

Abstract

Corporate boards advise management on key strategic decisions of the firm including the firm’s financing policies. However, the degree to which they can perform this task hinges upon their level of access to and their understanding of firm-specific financial information. In this study, I examine the relations between firm financing decisions and whether or not their boards have an internal financial expert. I find larger firms and those with fewer growth options, where value creation through sophisticated management of capital structure is relatively more important, are more likely to have an internal financial expert on their board. Firms with internal financial expertise on their board exhibit greater financial flexibility as evident in their association with greater changes in leverage, higher frequency of debt issues and the greater use of short-term debt financing. I find no evidence these firms engage in greater M&A activity, though they are more likely to finance acquisitions with 100% cash. Finally, shareholders react favorably to the news of an internal financial expert’s appointment to their board. These findings illustrate the value of board internal financial expertise in managing firm capital structure and financing decisions in a manner beneficial to shareholders. This is especially important in the post-Sarbanes-Oxley era where firms are mandated to increase board outside financial expertise and, at least implicitly, forced to reduce the role of internal financial expertise on their boards.