Boards are crucial to shareholder wealth. Yet, little is known about how shareholder oversight affects director incentives. Using exogenous industry shocks to institutional investor portfolios, we find that institutional investor distraction weakens board oversight. Distracted institutions are less likely to vote against ineffective directors, while directors with poor proxy voting outcomes depart less frequently. Consequently, independent directors face weaker monitoring incentives and exhibit poor performance. Also, ineffective independent directors are more frequently appointed. Such firms exhibit more earnings management, high unexplained CEO pay, and lower valuation. Our findings suggest that institutional investor monitoring creates important director incentives to monitor.
William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance
Harvard Law School
Nicholas J. Chabraja Professor
Northwestern University School of Law and Kellogg School of Management