The market reaction to the appointment of outside directors

Abeyratna Gunasekarage · Debra K. Reed

20 citations0/0 files storedInternational Journal of Managerial Finance

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Corporate Finance and Governance Financial Markets and Investment Strategies Auditing, Earnings Management, Governance

Abstract

Purpose The purpose of this study is to examine the character of any market response to the appointment of outside directors. The main propositions tested are: whether the stock market responds unconditionally to these appointments or whether the market response is conditional on the degree of the agency problem faced by the firm and the affiliation of the appointees. Design/methodology/approach The authors use a New Zealand sample of the appointments of outside directors during the period from July 1999 to June 2004. The unconditional market response is examined analysing the abnormal returns generated by the appointing companies during the three‐day announcement period. The influences of the agency problem and the affiliation of directors are tested by employing multiple regressions. Findings The findings provide strong support for the second proposition; the market considers the degree of the agency problem faced by the firm and the affiliation of outside directors in responding to these appointments. The percentage of outside directors in the board emerged as the strongest governance mechanism which, together with firm size, posed a significant inverse influence on announcement period abnormal returns. A strong interaction effect between appointee status and the agency problem was not present. Originality/value The mere appointment of outside directors may not please the firm's investors. Such appointments are more useful for companies with severe agency conflicts; even if such a conflict is present, the affiliations that these outside directors have with the executives and the operations of the appointing companies may need to be considered in determining the value of such appointments.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1983Separation of Ownership and Control 1992The Cross-Section of Expected Stock Returns 1986Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers 1997A Survey of Corporate Governance 1980Agency Problems and the Theory of the Firm 1996Agency costs of free cash flow, corporate finance, and takeovers 1993The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems

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