How Does the Method the Board of Directors Uses to Increase Board Independence Influence External Monitoring?

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Abstract

This study examines two fundamental, yet previously unaddressed, questions regarding the recent trend of increasing board of director independence; 1) “How do boards become more independent?” and 2) “What, if any, effect does the chosen route for increasing board independence have on the board’s monitoring role?”. Using the common definition of board independence: number of independent board members divided by the total number of board members, we document three distinct methods boards use to increase their independence. We then examine the influence that each method (or combination of methods) has on the amount of external monitoring the board purchases from the auditor. We find that boards which increase independence by reducing board size (i.e. they decrease the denominator in the above equation) purchase more external monitoring from the auditor than other boards. Additionally we find that boards which maintain their size, but replace non-independent directors with independent ones (i.e. the numeration and demonization stay the same, but their composition changes) purchase less external monitoring from the auditor than other boards. Finally we show a non-significant association between boards which increase independence through the addition of more board member (i.e. an increase in the denomination of the above equation) and the amount of external monitoring they obtain from the auditor, compared to other boards. Our study contributes to the literature on the influence of board independence, as well as, the effect changes in board structure have on the board’s relationship with a primary external monitor, the auditor.

Authors

• Christine Porter, The University of Kansas

• Matthew Sherwood, The University of Kansas