Under the microscope: An experimental look at board transparency and director monitoring behavior

• Published date: 01 April 2018
• Author: Yuehua Xu,Shanshan Lin,Hang Zhu,Weiwen Li,Ryan Krause,Junsheng Zhang,Xin Qin
• DOI: http://doi.org/10.1002/smj.2756
• Date: 01 April 2018

RESEARCH ARTICLE

Under the microscope: An experimental look

at board transparency and director monitoring

behavior

Weiwen Li

1

| Ryan Krause

2

| Xin Qin

1

| Junsheng Zhang

1

| Hang Zhu

1

|

Shanshan Lin

1

| Yuehua Xu

3

1

Business School, Sun Yat-sen University,

Guangzhou, China

2

Neeley School of Business, Texas Christian

University, Fort Worth, Texas

3

Lingnan College, Sun Yat-sen University,

Guangzhou, China

Correspondence

Ryan Krause, Neeley School of Business, Texas

Christian University, Fort Worth, Texas 76129.

Email: r.krause@tcu.edu

Xin Qin, Business School, Sun Yat-sen

University, Guangzhou, Guangdong Province,

510275, China.

Email: qinxin@sysu.edu.cn

Funding information

National Natural Science Foundation of China,

Grant/Award numbers: 71202095, No. 71572198;

No. 71202095; No. 71232009; No. 71332004;

No. 71502179; No. 71672205; No. 71372155;

No. 71602196; Ministry of Education of the

People's Republic of China, Grant/Award number:

17YJC630037

Research Summary: It is well known in corporate gover-

nance scholarship that independent directors differ in the

vigilance with which they monitor corporate insiders.

This difference depends largely on whether independent

directors are concerned more with their public reputation

or with their prospects in the director labor market. The

explanation for this difference depends on an assumption

of information asymmetry, however. In the present study,

we relax the assumption of information asymmetry to

examine how boardroom transparency affects directors’

monitoring behavior. Using a randomized experimental

study of actual independent directors, we find that board-

room transparency amplifies the effect of directors’incli-

nations toward either active or passive monitoring, with

directors inclined toward vigilant monitoring becoming

even more vigilant, and directors inclined toward passive

monitoring becoming even more passive.

Managerial Summary: In most advanced economies, the

board’s internal decision processes are either undisclosed

or disclosed only to a very limited extent. It remains

unknown, then, whether directors would behave differ-

ently if their behaviors were made public. We find that

when their actions are disclosed to the public, directors

concerned with their public reputations become more vigi-

lant, whereas those concerned with their prospects for

additional board seats become more passive in monitoring

corporate insiders. Whereas regulatory bodies and corpo-

rate governance watchdogs have recently advocated for

greater disclosure of the boardroom decision-making pro-

cess, our study suggests that such mandatory disclosure

Received: 5 August 2016 Revised: 11 October 2017 Accepted: 13 October 2017 Published on: 30 January 2018

DOI: 10.1002/smj.2756

1216 Copyright © 2017 John Wiley & Sons, Ltd. wileyonlinelibrary.com/journal/smj Strat Mgmt J. 2018;39:1216–1236.

requirements can exacerbate, rather than alleviate, the

problem of passive director monitoring.

KEYWORDS

dual labor market, ex-post settling up, independent

directors, information asymmetry, monitoring behavior

Boards are like subatomic particles—they behave differently when they are being

observed.

Nell Minow, editor and co-founder of The Corporate Library

(CFO Magazine, 2003)

1|INTRODUCTION

Normative agency theory prescribes that independent directors act as vigilant monitors to keep power-

ful insiders in check (Eisenhardt, 1989; Fama & Jensen, 1983). Nevertheless, decades of research on

boards of directors have revealed that while directors can be active and shareholder oriented, often

they are passive and insider oriented (Westphal & Zajac, 1995; Zajac & Westphal, 1996). Scholars

generally acknowledge that independent directors face conflicting incentives when choosing how vig-

ilantly to monitor. On the one hand, independent directors may be “concerned about the effect of stra-

tegic decisions on their personal reputation and potential personal liability”(Deutsch, Keil, &

Laamanen, 2011, p. 215). On the other hand, considerable research has shown that directors increase

their opportunities for future board placement if they appear “sympathetic”to the interests of insiders,

either indirectly through participation in conciliatory board decisions or directly through interpersonal

assurances (Westphal & Stern, 2007; Westphal & Zajac, 1995; Zajac & Westphal, 1996).

Economic theory suggests that the labor market should punish independent directors for passiv-

ity and reward them for vigilance (Fama, 1980; Yermack, 2004). What prevents such ex-post set-

tling up is the information asymmetry that exists between directors and external observers. Absent

public knowledge of individual directors’monitoring behavior, independent directors can demon-

strate their passivity to insiders at other boards while keeping their public reputations intact. They

can show their passivity through collective board actions, such as not challenging insiders when

warranted, decreasing board control over insiders, or even providing insiders with unearned rewards

(Zajac & Westphal, 1996).

Thus, information asymmetry is a crucial boundary condition for theory predicting director mon-

itoring behavior. It remains unclear how directors’monitoring behavior might change if information

became more symmetric. Economic theory suggests that a reduction in information asymmetry

would make the market more efficient, and as a result should incentivize directors inclined toward

passivity to monitor insiders more vigilantly (Rose, Mazza, Norman, & Rose, 2013). In contrast,

many corporate governance scholars have argued that the director labor market is bifurcated, with

some boards seeking active directors and other boards seeking passive directors (see Withers, Hill-

man, & Cannella, 2012). According to Finkelstein, Hambrick, and Cannella (2009, p. 242), “the

notion that there is a bifurcated market for directors changes the calculus of Fama’s (1980) ‘settling

LI ET AL.1217