How do independent directors influence innovation productivity? A quasi-natural experiment

ABSTRACT

Due to managerial myopia, managers may be reluctant to make long-term investment decisions that do not produce immediate results. Effective corporate governance can align managers’ short-term-oriented incentives with shareholders’ long-term interests. Because the board of directors is the paramount governance mechanism, we explore the role of board governance on managerial myopia. In particular, we investigate the effect of independent directors on corporate innovation. To minimize endogeneity, we exploit the passage of the Sarbanes–Oxley Act as an exogenous shock that raises board independence. Our difference-in-difference estimates show that board independence leads to significantly higher investments in innovation as well as higher innovation productivity. Our results are consequential as they show that board governance has a palpable effect on important corporate outcomes such as innovation productivity.

KEYWORDS:

• Independent directors
• innovation
• agency theory
• corporate governance
• board of directors
• SOX

JEL CLASSIFICATION:

• G32
• G34

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ In the model, we do not include the ‘Noncompliant’ dummy variable because it becomes unnecessary when firm fixed effects are included.

² As a robustness check, we conduct an analysis using propensity score matching based on 12 firm characteristics and 4 board characteristics (all 12 control variables in the regression analysis). For each noncompliant firm, we look for a matched control firm that is compliant (already having a majority of independent directors on the board before the passage of the SOX Act). Therefore, our treatment and control groups are nearly identical in almost every dimension except one, i.e. board independence. Then, we re-estimate all the regressions based on the matched sample. The results remain consistent and appear to be robust.