International Review of Economics and Finance 8 1999 421–431
The value of financial outside directors on corporate boards
Yung Sheng Lee
a,
, Stuart Rosenstein
b
, Jeffrey G. Wyatt
c
a
Citibank, Singapore
b
University of Colorado at Denver, Graduate School of Business Administration, Campus Box 165, P.O. Box 173364, Denver, CO 80217, USA
c
Department of Finance, Miami University, Oxford, OH 45056, USA Received 8 January 1998; accepted 24 September 1998
Abstract
The appointment of a financial outside director to the board of a public corporation is associated with positive abnormal returns, attributable entirely to the smaller than median-
size firms in our sample. In addition, investment bankers are appointed to the boards of much smaller companies, on average, than commercial bankers or insurance executives. These results
suggest that smaller firms, which may have limited access to financial markets and less financial expertise, benefit substantially from these appointments.
1999 Elsevier Science Inc. All
rights reserved.
JEL classification: G30
Keywords: Corporate governance; Board of directors
1. Introduction
Although a growing number of empirical studies find support for the value of outside directors, there is little research into the value of outside directors relative to
their specific occupations or types of experience. In this article, we focus on outside directors recruited from different types of financial institutions. We examine the share
price reaction to announcements of the appointment of financial outside directors.
Fama and Jensen 1983 claim that outside directors can add value both as monitors of management and providers of “relevant complementary knowledge” p. 315. How-
Corresponding author. Tel.: 303-556-6518; fax: 303-556-5899. E-mail address
: srosensteincastle.cudenver.edu S. Rosenstein 1059-056099 – see front matter
1999 Elsevier Science Inc. All rights reserved.
PII: S1059-05609900039-8
422 Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431
ever, there is some disagreement with respect to the value of financial outside directors. While Easterbrook 1984 contends that contributors of capital are very good monitors
of management, Brickley et al. 1988 claim that most financial outside directors are drawn from organizations that are sensitive to pressure from management and,
therefore, may not be independent in their judgments. Evidence by Rosenstein and Wyatt 1990 indicates that the addition of an outside director who is an officer of a
financial firm increases shareholder wealth. However, Rosenstein and Wyatt 1990 treat all financial outside directors as a homogeneous group.
In this article, we contend that commercial bankers, insurance company executives, and investment bankers are heterogeneous groups, bringing different types of expertise
and reputational capital to boards of directors. Thus, we examine whether there are differential share price reactions associated with appointments of outside directors
from each of these groups. As in Rosenstein and Wyatt 1990, we find that the appointment of a financial outside director to the board of a public corporation is
associated with positive abnormal returns. We cannot reject the hypothesis that abnor- mal returns are equal across the three groups.
More importantly, abnormal returns are significantly positive for firms that are below the median market value of our sample, suggesting that small firms, which have
less access to financial markets and less financial expertise, benefit substantially from the addition of a financial outside director to their boards. For the smaller firms, we
find that abnormal returns are significantly positive for both commercial bankers and investment bankers, but not for insurance company executives. In addition, we find
that firms that add investment bankers are much smaller, on average, than those that add commercial bankers or insurance company executives.
The article is organized as follows: We first discuss prior research and then develop testable implications. The data collection procedure and empirical methods are then
outlined. Empirical results are presented, and finally, conclusions are drawn.
2. Prior research
