Stock market reaction to the appointment of outside directors

Views concerning the contribution of outside directors are mixed. Attempts to generalise about their value are hindered to a large extent by considerable heterogeneity with respect to their monitoring incentives and abilities. For example, although many outsiders are senior managers in other firms and, as such, fit the standard corporate-specialist mould, a large number are non-business experts whose backgrounds include politics, law, education and the arts. Furthermore, with current and retired managers, financiers and business consultants frequently serving as outside directors, substantial diversity exists even within the corporate-specialist group. Moreover, to the extent that they are appointed to act as monitors of management, the governance benefits of outside directors are likely to depend to a large degree on the magnitude of the perceived agency problem. The objective of this paper is to examine the way agency considerations and individuals' monitoring incentives interact to determine the benefits (and costs) of appointing outside board members. © Blackwell Publishing Ltd 2003.