Board Games: Timing of Independent Directors’ Dissent in China
Executive Summary — Independent directors are an integral part of corporate governance. Despite the copious scholarly debates surrounding board independence, however, little progress has been made in studying the inner workings of public boards. Fortunately, the regulatory environment in China offers a rare window to observe the inner workings of independent directors. This paper is one of the first statistical investigations of the circumstances under which so-called "independent" directors voice their independent views. The authors explore the following questions: 1) Why do independent directors dissent? 2) Under which circumstances is an independent director more likely to issue an open dissent? and 3) Does dissent matter sufficiently to affect independent directors' careers and firm performance? Unlike most of the previous models that view boards as a monolithic entity that "shares a common agenda on all matters," this study allows the authors to see boards as consisting of individuals with different utility functions and to examine board behaviors at the individual director level. Key concepts include:
- Independent directors dissent more when social connections that might hold back a dissent is less constraining on one hand, and when firms have poor performance that might impose threats to independent directors' personal reputations on the other hand.
- Boards can be reconceptualized: not as monolithic checks on managerial actions, but as social institutions with emergent norms, and sanctions and rewards to (non-)compliance on occasion.
- The labor market not only rewards independent directors for their superior decision making expertise, but also punishes those who openly challenged listed companies' management teams.
- For Chinese independent directors, this work suggests an inescapable dilemma whereby the Confucian doctrine of Golden Mean is the only survival guide. That is, independent directors must ensure that their relationships with listed companies are conducted on an open and mutually advantageous basis.
- On one hand, independent directors need to build a good public reputation for being an active monitor, and on the other hand, they need to establish a good "private" reputation for being friendly with the controlling shareholders and top management.
This paper examines the circumstances under which so-called "independent" directors voice their independent views on public boards in a sample of Chinese firms. Controlling for firm and board characteristics, we find that independent directors' dissent is associated with breakdown of social ties between the independent director and the board chairperson, who locates at the center of the board bureaucracy in China. In particular, independent directors tend to "time" their dissent into a restricted set of socially appropriate circumstances. Dissent is more likely to occur when the chairperson who appointed the independent director has left the board. Dissent also tends to occur at the end of board "games," defined as a 60-day window prior to departure of the board chairperson or departure of the independent director herself. The endgame effect is particularly strong, seeing 27% of the dissent issued at board "endgames," which represents only 4% of independent directors' average tenure. While directors with foreign experience are more likely to dissent, we do not find that academics, accounting, and law professionals are significantly more active in dissenting. We also show that dissent is consequential, to the director and the firm. For directors, dissent significantly increases the likelihood for a director to exit the director labor market. For firms, around announcement of dissent, firms suffer an economically and statistically significant cumulative abnormal return of -0.97%. Although literature has suggested that dissent might be reflective of diverse viewpoints, and perhaps beneficial in and of itself through reduction of firm variability, we do not find this offsetting beneficial effect to be strong.