Board directors with foreign experience and stock price crash risk: Evidence from China

• Author: Feng Cao,Rongli Yuan,Jian Sun
• Date: 01 October 2019
• DOI: http://doi.org/10.1111/jbfa.12400
• Published date: 01 October 2019

DOI: 10.1111/jbfa.12400

Board directors with foreign experience and stock

price crash risk: Evidence from China

Feng Ca o1Jian Sun2Rongli Yuan3

1Business School, Hunan University, Changsha,

China

2School of Accountancy, CentralUniversity of

Finance and Economics, Beijing, China

3Renmin Business School, Renmin University of

China, Beijing, China

Correspondence

RongliYuan, Renmin Business School, Renmin

Universityof China,No. 59 Zhongguancun

Street,Haidian District, Beijing, China, 100872.

Email:yuanrongli@rmbs.ruc.edu.cn

Fundinginformation

NationalNatural Science Foundation of China,

Grant/AwardNumbers: 71602053, 71672208,

71872179;Hunan Provincial Natural Science

Foundationof China, Grant/AwardNumber:

2018JJ3087;China Postdoctoral Science Foun-

dation,Grant/Award Number: 2016M602413;

Programfor Innovation Research in Central

Universityof Finance and Economics

Abstract

This study examinesthe impact of board directors with foreign expe-

rience (BDFEs) on stock price crash risk. We find that BDFEs help

reduce crash risk. This association is robust to a series of robustness

checks, including a firm fixed effects model, controlling for possibly

omitted variables, and instrumental variable estimations. Moreover,

we find that the negative association between BDFEs and crash

risk is more pronounced for firms with more agency problems,

weaker corporate governance, and less overall transparency. Our

findings suggest that the characteristics of board directors matter in

determining stock price crash risk.

KEYWORDS

board directors, foreign experience, monitoring role, stock price

crash risk

JEL CLASSIFICATION

G34, G38

1INTRODUCTION

The board of directors, as an agent of a firm’s shareholders, plays an essential role in the firm’s corporate governance

system. Prior literaturehas investigated the economic impact of the board of directors in terms of the number of direc-

tors (Cheng, 2008), directors’ compensation (Ye,2014), and the presence of independent directors (Nguyen & Nielsen,

2010). Recently,the individual characteristics of board directors have attracted greater attention from academics. For

example, White, Woidtke, Black, and Schweitzer (2014) focus on the appointment of academic directors, Field and

Mkrtchyan (2017) test the effect of directors with acquisition experience on acquisition performance, and Giannetti,

Liao, and Yu (2015) pay attention to the relationship between board directors with foreign experience (BDFEs) and

firm performance.

Studying and/or working in foreign countries for some period of time enables overseas talent to accumulate a

breadth of knowledge and/or professional experience; thus, these returnees tend to be effective monitors and have

a positive impact on the corporate governance of listed firms in emerging economies such as China. Within the huge

population of China, the number of directors with foreign experience is small, thereby making foreign experience an

important and rare characteristic. Giannetti et al. (2015) utilize the Chinese setting to explore the impact of BDFEs

1144 c

2019 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/jbfa JBus Fin Acc. 2019;46:1144–1170.

CAO ETAL.1145

on firm performance and find that firms with BDFEs have better performance than those without. Inspired by these

findings, we attempt to explore the impact of BDFEs on stock pricecrash risk.

The recent financial crisis has stimulated a renewed interest in understanding and predicting stock price crashes

(Kim, Wang, & Zhang, 2016). Prior studies suggest that managers, motivated by self-interest, hide bad news from

stakeholders, representing the primary cause of crash risk (Kim et al., 2016; Yuan, Sun, & Cao, 2016). However, the

accumulated negative information eventuallyreaches a tipping point and negative news floods the market, resulting in

a stock price crash. Crashes damage market integrity and investorconfidence (DeFond, Hung, Li, & Li, 2015), both of

which are essential to the healthy development of the stock market in emerging economies. In China, extremestock

price declines have significantly harmed the market. For instance, in 2001, the stock price of the Chinese listed firm

Yinguangxia (Stock ID: 000557) dropped from 30.8 yuan to 6.6 yuan in 15 trading days. In 2011, the market value of

another Chinese listed firm, Chongqingpijiu (Stock ID: 600132), shrunk by 75% within half a month. The shareholders

of these firms suffered huge losses and lost their confidence in the Chinese stock market around that time (Sun, Yuan,

Cao, & Wang, 2017). Therefore, it is of great importance to explore methods that decrease stock price crash risk in

China.

A growing number of studies link various determinants with stock price crash risk (e.g., Andreou, Louca, & Petrou,

2017; Chen, Kim, & Yao,2017; Kim et al., 2016; Li, Wang, & Wang, 2017), but little is known about the impact of BDFEs

on crash risk. We fill this voidby exploring the impact of BDFEs on stock price crash risk. This is an important research

question, as its findings may have implications for securities regulators, firms, and investors who are interested in

reducing crash risk.

Based on a sample of Chinese listed firms from 1999 to 2017, we find a significantly negative association between

BDFEs and stock price crash risk. Our results suggest that BDFEs help reduce future stock price crashrisk. These find-

ings hold after addressing endogeneity using a firm fixed effects model, controlling for possibly omitted variables, and

conductinginstrumental variable estimations. In addition, we find that the negative relation between BDFEs and future

crash risk is more significant for firms with more agency conflicts, weaker corporate governance, and lower overall

transparency.

We make two important contributions to the literature. First, we contribute to the growing body of literature on

the effects of corporate managers’ different individual experiences on financial decisions. Prior studies have focused

on executive internal experience(Brockman, Campbell, Lee, & Salas, 2019), disaster experience (Bernile, Bhagwat, &

Rau, 2017), military experience (Koch-Bayram & Wernicke,2018), pilot experience (Sunder, Sunder, & Zhang, 2017),

academic experience (Jiang & Murphy, 2007), and mandatory management earnings forecast experience(Huang, Li,

Tse,& Tucker,2018), but are almost silent on individual foreign experience, especially in emerging markets like China.

TakingChinese listed firms during 1999–2009 as an example, Giannetti et al. (2015) find that directors with foreign

experience improvefirm performance in China. Unlike Giannetti et al. (2015), this study explores the impact of BDFEs

on stock price crash risk, a hitherto unexplored area in the literature. One may not expect a better-performing firm

to experience less crash risk, as the most direct reason for a stock price crashrisk is corporate information disclosure

behaviour (Jin & Myers,2006), rather than firm performance. Prior studies have provided mixed empirical evidence on

theimpact of performance on crash risk.1Therefore, this study enriches the literature on both the effects of managerial

experience on corporatefinancial decisions and the economic consequences of BDFEs.

Second, this study adds to the literature on the determinants of stock price crash risk. Prior studies have investi-

gated various factors associated with crash risk. Forexample, accounting conservatism (Kim & Zhang, 2016), stock liq-

uidity (Chang, Chen, & Zolotoy,2017), China’s split-share structure reform (Sun et al., 2017), China’s closed pyramidal

managerial labour market(Chen, Kim, Li, & Liang, 2018), and crackdowns on corruption (Chen, Xie, You,& Zhang, 2018)

are all negativelyassociated with crash risk, while younger CEOs (Andreou et al., 2017), overconfident CEOs (Kim et al.,

1Some studies find better-performing firms to experience less stock price crashrisk (e.g., Hutton, Marcus, & Tehranian, 2009; Kim, Li, & Zhang, 2011; Yuan

etal., 2016; Chen et al., 2017; Cao, Ye, Zhang, & Li, 2018; Kim, Yeung,& Zhou, 2019), while others provide different conclusions (e.g., Kim, Li, & Li, 2014; Callen

&Fang, 2015, 2017; Kim et al., 2016; Dang, Lee, Liu, & Zeng, 2018; Chen, Kim et al., 2018; Chen, Xie et al., 2018; Jia, 2018).