The Effect of Short-Selling on the Ratio of Independent Directors

Abstract

This study examines how a short-selling threat affects firms’ board composition. We propose that firms will decrease the ratio of outside directors in their board when there is a short-selling threat because firms are concerned about outside directors leaking information to the financial market. To test this hypothesis, we exploit an exogenous shock in the US stock market associated with Regulation SHO whereby the Securities and Exchange Commission (SEC) randomly selected pilot firms for which the uptick restriction on short-selling no longer applied. We also examine the previous short-selling threat, the presence of executive directors on the nomination committee, and stock ownership by outside directors as contingencies. This research contributes to the literature on independent directors by adding a novel perspective that highlights the impact of independent directors as an information conduit.