Hiring “tainted” outside directors on the board

• Date: 01 January 2020
• Published date: 01 January 2020
• Author: Soohyung Kim
• DOI: http://doi.org/10.1002/jcaf.22425

BLIND PEER REVIEW

Hiring “tainted”outside directors on the board

Soohyung Kim

Sykes College of Business, University of

Tampa, Tampa, Florida

Correspondence

S. Kim, Sykes College of Business,

University of Tampa, Tampa, FL 33606.

Email: sokim@ut.edu

Abstract

By looking at the unique data set during the period from 2011 to 2015, this

research presents evidence that a firm's decision to hire a tainted outside direc-

tor (OD) onto its board produces significantly improved firm performance. I

defined tainted ODs as ODs that are (were) senior executives at other firms

where class action lawsuits were filed on behalf of an investor group that had

suffered a financial loss in a stock. Especially, for the firms that appointed

tainted OD as the chair of audit committee, their industry-adjusted return on

assets is significantly increased by 6.8%. These results mean that under the

presence of career concerns theory, tainted OD's history directly related to a

previous securities class action lawsuit is a unique experience that modifies

and disciplines their future behavior and eventually helps improve firm perfor-

mance. Thus, through appointing tainted OD as an audit committee chair the

firm might be able to reinforce the monitoring and transparency of its board,

resulting in significantly better firm performance than any other control firms.

KEYWORDS

board of directors, CEO appointment, firm performance, securities class action

JEL CLASSIFICATION

G30; G32; G34

1|INTRODUCTION

Since the advent of Sarbanes-Oxley (SOX) and various

corporate scandals related to governance, firms are

required to keep a certain proportion of independent

directors and the role of outside directors (ODs) in

implementing corporate governance has dramatically

increased. Linck, Netter, and Yang (2009) show that the

increased responsibility of ODs is directly related to a dra-

maticincreaseindirectors'compensationpost-SOX.Onthe

other hand, the number of multiple directorships held by

top executives/directors has decreased, partially explained

by the increased workload of directors (Spencer Stuart US

Board Index, 2011). These labor market phenomena for

directors have generated higher demand than supply for

directors; “Board seats are going begging, Fortune, 2005.”

However, the firm cannot hire unqualified ODs to its board

simply to adhere to the SEC regulations as the directors'

ability directly relates to the firms' performance.

A pertinent question presents itself if one firm decides

to hire the “tainted outside director”who is (was) one of

the top executives but struggled due to legal issues, spe-

cifically in this study's regard, to federal class action fraud

lawsuits. The class action lawsuit is brought forward on

behalf of investors who have suffered a financial loss in

stock equity and includes investment fraud, unsuitable

investments, churning, pricing violations, improper exe-

cution of trades, and bad investment advice. So, is it the

right decision to take on these tainted ODs in order to

maximize the firm's shareholder wealth?

Interestingly, many top executives that struggled due

to such corporate governance legal issues remain in their

posts or are hired as ODs at other firms. For example,

Steve Odland, former CEO of Office Depot, was forced

Received: 1 October 2019 Accepted: 26 October 2019

DOI: 10.1002/jcaf.22425

100 © 2019 Wiley Periodicals, Inc. J Corp Acct Fin. 2020;31:100–111.wileyonlinelibrary.com/journal/jcaf