The Market Hates a Monitor: The Adverse Selection of Independent Directors Who Oust a CEO

Abstract

Does the market for independent directors always incentivize directors to act in the best interests of shareholders? In this paper, we suggest that the market fails in this regard when the interests of shareholders diverge from the interests of managers, such as when directors must oust an underperforming CEO. Given that managers continue to wield primary influence over the director-selection process, we expect that directors who pursue the interests of shareholders to the detriment of corporate managers will be punished by the market for directors. To test this, we employ a unique longitudinal database that tracks a decade in the careers of a cohort of independent directors. We find evidence that directors who oust a CEO suffer multi-faceted adverse consequences in the market. They are likely to win seats within fewer boards and the boards that do recruit them are likely to be significantly smaller and less reputable than those that recruit their peers. Ultimately, these findings support calls for more deliberate shareholder accountability mechanisms in the market for directors, such as governance provisions that allow for more direct shareholder involvement in director elections.