Gray Directors and Board (Non-)Independence
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Sunwoo Hwang2 First Draft: January 2018 Abstract In this paper, I propose a new proxy for board (non-)independence, which is both correlated and causallyassociated with firm value, unlike its traditional proxy, within firm and CEO. The new proxy is whether a board is gray with at least one non-independent non-executive, or gray, director (NI-NED). First, consistent with the hypothesis that investors suspect unobservable non-independence of I-NEDs at gray boards, I show that investors find I-NEDs less valuable at gray boards than at non-gray boards using data on sudden director deaths. Using S&P 1500 firms from 1996 to 2016, I also show that firm value drops when a board turns gray and does not when it turns non-gray and more or less gray, the extent of which is stronger when information is scarcer and costlier to acquire. Second, using the 2004 cooling-off period introduction as a shock on the CEO’s pool of unobservably NI-NEDs, I show that firms run by the CEOs who have a larger fraction of excolleagues disqualified as I-NEDs are more likely to have gray boards and suffer a value loss by having gray boards after the shock. Last, I document higher agency costs at gray boards. It is worth emphasizing that all these findings hold and the new proxy is valid only in the post-Sarbanes-Oxley Act period, during which UNI-NEDs are pivotal in board control and the CEO’s pool of UNI-NEDs, rather than her bargaining power, is the primary source of NI-NEDs. JEL classification: G34, G38, K22 Keywords: board independence, board composition, gray director, and corporate governance.
I thank Martijn Cremers, Dragana Cvijanovic, Jesse Davis, Geoffrey Tate, and Xinxin Wang for helpful discussion and comments. 2 Kenan-Flagler Business School, The University of North Carolina at Chapel Hill, McColl Building, Chapel Hill, NC 27599, USA, E-mail:
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