Do Banks Price Independent Directors’ Attention?

Abstract

Masulis and Mobbs (2014), (2015) find that independent directors with multiple directorships allocate their monitoring efforts unequally based on a directorship’s relative prestige. We investigate whether bank loan contract terms reflect such unequal allocation of directors’ monitoring effort. We find that bank loans of firms with a greater proportion of independent directors for whom the board is among their most prestigious have lower spreads, longer maturities, fewer covenants, lower syndicate concentration, lower likelihood of collateral requirement, lower annual loan fees, and higher bond ratings. Our evidence indicates that independent directors’ attention is associated with lower cost of borrowing.

Audit Committee Members’ Reputation Incentives and Their Effectiveness in Monitoring the Financial Reporting Process

“…Second, we contribute to the recent literature on the effects of independent directors' reputation incentives. Prior research documents how independent directors' reputation incentives impact firm performance, CEO turnover (Masulis and Mobbs, 2014), cost of borrowing (Huang et al, 2018), and share price informativeness (Sila et al, 2017). We extend this line of research to the audit committee level by showing how audit committee members' reputation incentives impact the committee's monitoring effectiveness over the financial reporting process.…”

“…Specifically, Mobbs (2014, 2016) find that independent directors' reputation incentives motivate them to prioritize their time and effort to their more reputable directorships, thus improving their board attendance rate, subsequent firm performance, forced CEO departure sensitivity to poor performance, and CEO pay-performance sensitivity of the directors' more reputable firms. Further, prior research finds that both bank loan contract terms and stock price informativeness reflect independent directors' unequal allocation of monitoring effort based on the directorship's relative prestige (Sila et al, 2017;Huang et al, 2018). These results suggest that independent directors are motivated by reputation incentives, and the relative reputation value of each directorship influences the amount of effort that directors expend on their respective boards.…”

“…be regarded as an effective monitor are higher in the independent director's most prominent directorship (Masulis and Mobbs, 2014;Sila et al, 2017;Huang et al, 2018). This is because prominent firms offer independent directors greater opportunities for reputation building and career development (e.g., Adams and Ferreira, 2008;Knyazeva et al, 2013).…”

“…We adopt two measures of audit committee members' reputation incentives. First, consistent with Masulis and Mobbs (2014), Sila et al (2017), and Huang et al (2018), we use the percentage of audit committee members for whom this audit committee membership is their highest ranked based on market capitalization as our first measure of audit committee members' varying reputation incentive effects. Various studies report results consistent with the notion that directorships in larger firms provide higher reputation incentives to directors (Shivdasani, 1993;Yermack, 2004;Ryan and Wiggins, 2004;Adams and Ferreira, 2008;Knyazeva et al, 2013).…”

“…Finally, our study contributes to a deeper understanding of the role of reputation in financial markets. Prior studies find that the actions of business professionals, such as financial analysts (Cowen et al, 2006;Clarke et al, 2007;Fang and Yasuda, 2009), investment bankers (Carter et al, 1998), auditors (Reynolds and Francis, 2001), independent directors (Masulis and Mobbs, 2014;Sila et al, 2017;Huang et al, 2018), and investors (Cao et al, 2015), are influenced by reputation concerns. Our study extends these studies to audit committee members and shows that their monitoring effectiveness is also influenced by the relative reputation value offered by their respective audit committee memberships.…”