Board Structure and Price Informativeness

This post comes to us from Daniel Ferreira, Associate Professor of Finance at the London School of Economics, Miguel Ferreira, Associate Professor of Finance at the Universidade Nova de Lisboa, and Clara Raposo, Professor of Finance at Instituto Superior de Economia a Gestao.

In our paper, Board Structure and Price Informativeness, forthcoming in the Journal of Financial Economics, we theoretically and empirically identify important interactions between internal and external governance mechanisms. We find evidence that stock market monitoring is a substitute for board monitoring. The strength of this relation is influenced by other governance mechanisms such as pay-performance sensitivity and the market for corporate control.

We add a new element to the list of determinants of board structure – price informativeness. We find robust empirical evidence that stock price informativeness is negatively related to board independence. The correlation between price informativeness and board independence is as strong as the ones between board independence and other firm-level variables that have been documented in the literature on corporate boards. Given our long list of control variables and the use of fixed-effects methods, it is unlikely that price informativeness is capturing the effects of omitted variables.

Our model delivers many empirical predictions that find support in the data. The negative relation between price informativeness and board monitoring is particularly strong for firms with few takeover defenses, high concentration of institutional shareholders, high pay-performance sensitivity in CEO compensation, and low firm-specific knowledge. We conclude that the strength of the substitutability between price informativeness and board independence can only be accurately measured when taking into account the overall governance framework.

Our results suggest that, if stock prices are informative, stock markets are able to perform a monitoring role like the one normally associated with the board of directors. The evidence that more informative prices are associated with a lower degree of board independence, fewer board meetings, low attendance at board meetings, and smaller board size all point in the same direction: firms with more informative stock prices require less demanding board structures. Our findings suggest that stock price informativeness affects optimal organization design.

The full paper is available for download here.

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