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E-MailIan D. Gow is Professor at the University of Melbourne; Aida Sijamic Wahid is Assistant Professor of Accounting at University of Toronto Rotman School of Management; and Gwen Yu is an associate professor at the Ross School of Business at the University of Michigan. This post is based on their recent article, published in the Journal of Accounting and Economics.
Board of directors play an important role in firms. However, there are many challenges in assessing the quality of directors. Investors may have limited information to judge the qualification of a director. Even if information was available, the required skillset one considers important for a director to be qualified for the job is inherently subjective.
Firms are required to disclose their directors’ backgrounds in proxy filings, otherwise known as Form DEF 14A. Director biographies are a required element of corporate filings in the United States. They are intended to provide investors with information needed to assess directors’ experience and to evaluate whether directors are adequately qualified to monitor and advise their firm (Securities and Exchange Commission, 2009). However, key elements of director biographies (e.g., past directorships) were relatively unregulated before 2010, giving directors and firms substantial discretion over the information disclosed.
In our article entitled Managing Reputation: Evidence from Biographies of Corporate Directors, we examine if there is evidence of strategic disclosure in director biographies and if so, whether such strategic disclosure bears real consequences. We find evidence consistent with strategic disclosure being present in director biographies. We find that disclosure of directorship experience is more likely to be withheld when it was held at a firm that experienced an adverse event during the director’s tenure. A previous or current directorship is less likely to be disclosed if, during the director’s tenure, the other firm experienced an adverse event such as an accounting restatement, securities litigation, or bankruptcy. For example, prior to increased SEC regulation in 2010, the probability of non-disclosure of a directorship at a firm that filed for bankruptcy during the director’s tenure is 35%, compared to 21% for directorships held at firms where no such adverse events occurred.
Non-disclosure rates for adverse-event directorships decline significantly after the SEC mandated the disclosure of recent past directorships, which suggests that the regulation had some effect on the withholding of unfavorable information. In 2010, the SEC amended the rules on disclosure in director biographies (See https://www.sec.gov/rules/final/2009/33-9089.pdf). Prior to these amendments, directors and nominees were required to disclose only directorships held at the time of filing. As the amendments expanded the disclosure obligation to include all directorships held at any point in the previous five years, their disclosure moved from a voluntary regime to a mandatory one. We find that the non-disclosure of past directorships drops from 59% to 32% following the new SEC rules. More importantly, the decline in the non-disclosure of directorships is greater for directorships at firms that experienced an adverse event than for those at firms that did not, suggesting that the new regulations had some effect on curbing strategic disclosure.
We find that disclosing directorships held at troubled firms has capital market consequences. The average stock market reaction to director appointments is more negative when directors disclose such directorships than when they do not. This is consistent with investors viewing the appointment of a director associated with an adverse-event firm as negatively affecting firm value and with the existence of frictions, such as search costs, that prevent investors from obtaining this information elsewhere.
We also find that disclosure choices have labor market consequences. Directors whose adverse-event directorships are disclosed are more likely to lose a current directorship in the two years after the filing than those who do not disclose. But we find no impact on a director’s ability to obtain new board seats, presumably because, regardless of the disclosure choices in proxy statements, the extensive vetting process for new directors uncovers these directorships. We find no evidence that either shareholder votes or the voting recommendations of the leading proxy advisor are associated with disclosure choices regarding adverse-event directorships.
The study has several implications. First, we contribute to research on reputation management by corporate directors. Several studies have shown that directors’ reputations are tarnished by a variety of events, such as supporting managerial actions that are against shareholder interests (Harford, 2003) or serving on the board of firms subject to lawsuits (Fich and Shivdasani, 2007), accounting restatements (Srinivasan, 2005), or financial distress (Gilson, 1990). Our article addresses the natural question of whether, given this evidence, information is withheld about directors’ association with troubled firms.
Second, we contribute to the literature on corporate disclosure by providing evidence from a setting in which we can directly observe the withholding of information. In most research settings, a researcher, like market participants, is unable to discern whether information is being withheld. The researcher can only draw inferences based on the absence of disclosure when firms have stronger incentives not to disclose (Aboody and Kasnik, 2000; Nagar et al., 2003). Our setting facilitates stronger inferences regarding the consequences of disclosure, as our direct measure of disclosure allows us to compare outcomes of cases when information is disclosed and cases when it is withheld.
Finally, we contribute to the recent literature that relies on biographies to infer the backgrounds and networks of individuals (Benmelech and Frydman, 2015; Bird et al., 2015; deHaan et al., 2015). Much of the disclosure on which these papers rely is voluntary and often filtered by firms and individuals. To the extent that reporting biases in biographies like those that we document hold in other settings, researchers may need to allow for the possibility that an affiliation with a failed company or other unfavorable information is omitted.
The complete article is available for download here.
