424 Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431
in their roles as appraisers of credit worthiness. The appointment of a commercial banker or insurance company executive may serve to reduce agency costs between
creditors and shareholders, increasing firm value. Our first hypothesis, then, is that there is a significantly positive wealth effect associated with the appointment of a
financial outside director to the board of a public corporation.
This article builds on previous research by examining the relative valuation effects of the three different types of financial directors. This examination is exploratory in
nature because there is little in the way of past empirical or theoretical work to guide hypotheses with respect to relative valuation effects. Brickley et al. 1988 characterize
all three groups as “pressure-sensitive,” meaning that the potential for business rela- tionships with the firms on whose boards they sit may cause these directors to be less
than arm’s length monitors of management performance. This pressure, along with the more complete understanding of the companies gained as a result of their serving
on the board, may result in lower financing costs.
As experts in credit analysis, commercial bankers and insurance company executives on the board might also be expected to mitigate agency problems between shareholders
and creditors. Investment bankers, on the other hand, are associated with both debt and equity issues, and also with acquisition activity. While their expertise might be
valuable, there is little reason to expect that they would mitigate agency costs more or less than any other outside director. In the absence of a more complete theory,
we make no predictions with respect to the relative valuation effects of appointments of these three types of financial director.
Directors are rarely recruited from pressure-resistant organizations public pension funds, mutual funds, endowments, and foundations owning at least 1 of the firm’s
stock; see Brickley et al., 1988, either because of legal restrictions, tradition, or because corporate managements do not want them on their boards. Therefore, we
cannot test the relative wealth effects of appointments of pressure-sensitive versus pressure-insensitive financial outside directors.
Our second testable hypothesis is that wealth effects associated with the appointment of a financial outside director are inversely related to firm size. It is generally recognized
that small firms have less access to financial markets than do large firms and are less likely to be covered by securities analysts. In addition, small firms are less likely to
be able to support the necessary staff personnel to maintain expertise in all forms of financial dealing. Thus, the appointment of a financial director to the board may be
more valuable for small firms than for large firms. Again, we make no predictions with respect to relative valuation effects across the types of financial directors.
4. Data and methodology
4.1. Sampling procedure The data set used in this study was acquired from Rosenstein and Wyatt 1990.
In this study, only the subsample of financial directors is used. The data collection technique is described below.
Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431 425
An outside director is defined as a director who is not a present or past employee of the firm and whose only formal connection with the firm is his or her duties as a
director. Board members whose appointments are directly attributable to ownership of shares in the corporation, either directly or as agents, are excluded from the
sample. The initial data set includes all of the Wall Street Journal’s “Who’s News” announcements of the appointment of only one outside director and no inside directors
over the 1981–1985 period. Firms in the sample also must have returns available on the CRSP Daily Stock Return database. This selection criteria is used to remove two
potential biases. First, the appointment of several directors may signal a significant change in strategy, which may result in confounding abnormal returns. Second, the
appointment of an inside director may signal that the CEO is planning to step down, and might also result in confounding abnormal returns.
The data set is further refined using the following criteria: 1. Announcements are eliminated if the news item is contaminated by information
about corporate personnel changes, merger, or other activity. 2. Announcements are eliminated if there are any missing returns over the period
from 170 days before through 20 days after the announcement. Missing returns may indicate a halt in trading occasioned by a major event such as merger or
bankruptcy that may result in changes to the board. 3. Announcements are eliminated if inspection of SEC 13D filings indicate that
newly appointed directors, or the entities with which they are affiliated, hold a 5 or greater ownership stake in the sample firm. This step is taken to eliminate
director appointments that were likely to have been initiated by shareholders.
Rosenstein and Wyatt’s 1990 final sample contains 1,251 announcements. Of these, 217 are financial outside directors, including individuals from the following types
of firms: commercial banks, insurance companies, investment banks, fund managers, savings and loans, venture capital firms, and other unclassified financial firms. An-
nouncements then are eliminated if categories overlap for example, fund managers are often associated with brokerage houses having investment banking departments
or where the appointee’s occupation could not be clearly categorized. Because the resulting sample contains very few directors who were not employees of commercial
banks, insurance companies, or investment banks, the final sample concentrates solely on those three categories. The final data set contains 146 announcements of the
appointment of an outside director from a commercial bank, insurance company, or investment bank.
4.2. Sample characteristics Sample characteristics are presented in Table 1. The distributions of announcements
by year and month are shown in panels A and B, respectively. The data in B indicate that the frequency of announcements is relatively uniform throughout the year, even
though the proxy season occurs in April and May. This result indicates that the first announcement of the appointment of a financial outside director is generally made
through the news media rather than the proxy statement. Panel C shows that commer-
426 Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431
Table 1 Characteristics of a Sample of 146 Announcements of the Appointment of an Outside Financial Director
to the Board of a NYSE or AMEX Corporation as Reported in the Wall Street Journal “Who’s News” Section over the Period 1981–1985
A. Frequency distribution of announcements by year 1981
1982 1983
1984 1985
Total Frequency
29 26
34 41
16 146
19.8 17.8
23.3 28.1
11.0 100
B. Frequency distribution of announcements by month Jan.
Feb. Mar.
Apr. May
June Frequency
12 17
12 15
21 7
8.2 11.6
8.2 10.3
14.4 4.8
July Aug.
Sep. Oct.
Nov. Dec.
Frequency 13
11 6
14 11
7 8.9
7.5 4.1
9.6 7.5
4.8 C. Frequency distribution of announcements by directors’ primary occupations
Employer type Frequency
of total Commercial bank
73 50.0
Insurance 39
26.7 Investment banks
34 23.3
Total 146
100.0 D. Market value of equity in millions of dollars of corporations at the end of the month preceding
the announcement Number of
Mean market announcements
value Smallest
Median Largest
Commercial bank 73 50.0
1762.4 6.9
460.3 14535.2
Insurance 39 26.7
1733.8 18.6
651.8 8187.7
Investment bank 34 22.3
305.9 4.1
144.3 1360.9
Total 146 100.0
1415.6 4.1
387.6 14535.2
cial bankers comprise 50.0 of the sample, with the remainder roughly equally divided between investment bankers and insurance company executives.
It is important to note that, on average, investment bankers are named to the boards of much smaller firms than commercial or investment bankers panel D. The
median mean market value of equity for firms that appoint investment bankers is just 144.3 305.9 million, significantly lower than the median mean market values
of 460.3 1,762.3 million for commercial bankers and 651.8 1,733.8 million for insurance company executives.
2
One possible explanation for this phenomenon is that smaller firms have a more difficult time placing securities issues and believe that a
relationship with a specific investment banking firm will be of assistance.
Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431 427
Table 2 Cumulative Average Prediction Errors CAPE and Test Statistics for the Two-day Announcement
Period AD-1, AD Surrounding Appointments of an Outside Director to the Board of a NYSE or AMEX Corporation as Reported in the Wall Street Journal “Who’s News” Section over the Period
1981–1985
positive over two-day announcement period
CAPE Z
statistic estimation period
Commercial bank 0.0056
1.48 0.59
b
N 5 73 0.48
Insurance 0.0022
0.26 0.46
N 5 39 0.48
Investment bank 0.0039
1.19 0.53
N 5 34 0.48
Total 0.0048
1.73
a
0.53 N 5 146
0.48
a
Statistically significant at the 0.10 confidence level two-tailed test.
b
Statistically significant at the 0.10 level for the standard test of proportions.
4.3. Statistical methods The announcement date AD is defined as the date that the announcement appears
in the “Who’s News” section of the Wall Street Journal. Standard event study methodol- ogy is used to measure abnormal returns. The market model is used for parameter
estimation, with the 150 trading day period AD-170, AD-21 used as the estimation period and the CRSP equally weighted index serving as the market index. The analysis
focuses on the 2-day announcement period AD-1, AD. See Furtado and Rozeff 1987 for a concise description of the method.
Two statistics are used to test the significance of prediction errors, the traditional parametric test statistic based on the 2-day cumulative standardized prediction error
3
CSPE, and the binomial test that the proportion of abnormal returns over the 2-day announcement period is different than the proportion of abnormal returns over the
estimation period.
5. Empirical results
