Learning from failures: Director interlocks and corporate misconduct

Abstract

Motivated by social learning and social network theories, we argue that firms learn from failures in their director interlocked firms. Empirical results show that enforcement for violations in errant firms inhibit misconduct commitments in focal firms (i.e., firms interlocked with errant firms). We investigate the role of interlocking directors in facilitating the inhibition of misconduct. Empirical results evidence that information transmission by interlocking directors plays a crucial role in the process of inhibitive learning. Besides information transmission, we also find that interlocking directors react with higher diligence in focal firms. Further, overall diligence of independent directors in focal firms is heightened. Additionally, we test several factors that influence the significance of this inhibition, including characteristics of interlocking directors, firm features, and industry characters. Finally, the enforcement can deter more than one form of misconduct in focal firms. Overall, we thoroughly investigate the reactions of focal firms and their directors. Our study focuses on inhibitive learning, which has received limited attention in corporate finance literature.