Outside Directors and Corporate Board Decisions: A Natural Experiment

Abstract

During the 1990s, the global economy appears to have suffered an outbreak of director mania - at least 18 countries have witnessed publication of guidelines that stipulate floors for the representation of outside directors on corporate boards. The apparent (largely untested) premise underlying this movement is that boards with significant outside directors will make different (and perhaps better) decisions than boards dominated by inside directors. As the first-mover in this movement, the U.K. provides a laboratory for a natural experiment to examine this presumption empirically. We investigate one key board task - the appointment of the CEO - to determine whether boards are more likely to appoint an outside CEO after they have increased the representation of outside directors to comply with the exogenously imposed standards. We find that the (coerced) increase in outside directors does alter the CEO selection decision. Additionally, announcement period stock returns indicate that the decisions are not only different, they also appear to be better.