We compare the trading performance of independent directors and other officers of the firm.We find that independent directors earn positive and substantial abnormal returns when they purchase their company stock, and that the difference with the same firm's officers is relatively small at most horizons. The results are robust to controlling for firm fixed effects and to using a variety of alternative specifications. Executive officers and independent directors make higher returns in firms with weaker governance and the gap between these two groups widens in such firms. Independent directors who sit in audit committees earn higher return than other independent directors at the same firm. Finally, independent directors earn significantly higher returns than the market when they sell the company stock in a window before bad news and around a restatement announcement. * We would like to thank Yakov Amihud, Patrick Bolton, Menachem Brenner, Eliezer Fich, Ilan Guedj, Kose John, Patricia Ledesma, Debbie Lucas, Randall Morck, Holger Mueller, Bernt Ødegaard, Matthew Richardson, Ioanid Rosu, Carola Schenone, Geoffrey Tate, Michael Weisbach, David Yermack, seminar participants at Columbia University, the Federal Reserve Bank of New York, Georgetown University, New York University, Northwestern University, and participants at the 2006 WFA Annual Meeting, the 2006 North American Summer Meeting of the Econometric Society, the 2006 SED Annual Meeting, and the Olin Washington University 3rd Annual Conference on Corporate Finance for their comments. We also thank Eliezer Fich for sharing his board size data with us. All remaining errors are our own.
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I IntroductionAfter recent scandals, policymakers around the world have responded by creating codes to improve ethical standards in business (e.g. Sarbanes-Oxley Act in the U.S., and the Cadbury Report and the Smith Report in the U.K.). A common theme in these guidelines is the independence of boards of directors that oversee corporate managers. For example, in 2002, the New York Stock Exchange and NASDAQ submitted proposals that required that boards had a majority of independent directors with no material relationships with the company. An independent director is defined as someone who has never worked at the company, any of its subsidiaries or consultants, is not related to any of the key employees, and does not/did not work for a major supplier or customer.
1The rationale for this policy recommendation is that board members with close business relationships with the company or personal ties with high-ranking officers may not assess its performance and practices dispassionately, or may have vested interests in some businesses practices.Some criticize the emphasis on independent board members, based on the claim that while they are independent in their scrutiny they have much less information than insiders. If the firm's executives want to act against the interest of the shareholders, they can simply leave outsiders in the dark. Thus, since they have very limited informati...
