Board independence and corporate governance: evidence from director resignations

As evident from recent changes in NYSE and Nasdaq listing requirements, board independence is considered an important constituent of firms?? corporate governance structures. However, the empirical evidence regarding the impact of board structure on firm performance is mixed. Since firms employ a variety of governance mechanism to control agency problems, the significance of board independence may depend upon the strengths of other governance mechanisms. I study the importance of board independence from the viewpoint of an investor by examining the market reaction to board member resignation announcements. I then examine this market reaction in the context of each firm??s existing governance structure and business environment. I find that investors react more negatively when an outside director resigns from the board than when an inside or gray director resigns. More importantly, I find that investor reaction to outside director resignation is less negative when insider or non-affiliated blockholder stock ownership is high. This evidence suggests that board independence and insider ownership and non-affiliated blockholder ownership may serve as substitutes. Furthermore, the evidence indicates that firms may require higher board oversight when a large part of managerial compensation is based on stock incentives. This finding suggests that overly high levels of stock-based managerial compensation may exacerbate agency problems. Taken together, these results have important implications for choosing an effective set of governance mechanisms that may work independently or in combination with each other to mitigate the agency cost of equity.