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
The corporate governance literature indicates that the composition of the board of directors is an important element in protecting the interests of shareholders, espe-
cially in cases of transactions where the interests of managers and outside shareholders may diverge.
1
A number of studies have also examined the value of outside directors under ordinary business conditions, when there is no publicly disclosed important
corporate control transaction occurring. For example, Rosenstein and Wyatt 1990 found that the appointment of an outside director results in a significant increase in firm
value. However, Bhagat and Black 1997 found that the proportion of independent directors is unrelated to future performance.
With respect to poor performance, Weisbach 1988 found that when firms perform poorly, CEO turnover is more likely when the board is dominated by outsiders.
Hermalin and Weisbach 1988 found that outside directors tend to join a firm after a firm performs poorly or withdraws from an industry. These outside directors may
be brought in for monitoring or to add specific expertise.
Y. S. Lee et al. International Review of Economics and Finance 8 1999 421–431 423
Several studies examine the characteristics of outside directors other than their specific occupations. For example, Kosnik 1990 found that a firm is more likely to
pay greenmail when the outside directors come from diverse backgrounds, perhaps indicating that a fragmented board is less able to ensure that management and share-
holder interests are closely aligned. Shivdasani and Yermack 1997 assert that the number of other outside directorships held by independent directors is important in
determining their value to the firm. Although several other outside directorships will be looked on as an indication of high quality, independent directors with more than
three additional directorships may be viewed as being too thinly spread to be effective. Shivdasani and Yermack show qualitative evidence to support this claim. Brickley et
al. 1994 found that on the adoption of a “poison pill,” the proportion of the board that are “professional directors” i.e., retired business executives and those who list
their occupation as being a director has a large positive influence on abnormal returns.
With respect to financial outside directors, Rosenstein and Wyatt 1990 find that appointments of financial outside directors are associated with significantly positive
abnormal returns. However, they cannot reject the hypothesis that outside directors from financial corporations, nonfinancial firms, or other occupational backgrounds
have a differential effect on firm value.
Booth and Deli 1997 studied the characteristics of firms that have financial direc- tors, finding that firms with a financial outside director have more debt than those
without a financial outsider. They then provided evidence consistent with the theory that financial outside directors provide expertise to the firms on whose boards they
sit, and not as a means of monitoring a business relationship.
In summary, the literature suggests that the financial markets discriminate among outside directors by their occupations and experience. In addition, there is some
evidence that financial outside directors have a specific value to corporations, setting the stage for an examination of valuation effects as a function of the type of financial
firm from which financial outside directors are drawn.
3. Testable implications
