Hiring “tainted” outside directors on the board

Abstract

By looking at the unique data set during the period from 2011 to 2015, this research presents evidence that a firm's decision to hire a tainted outside director (OD) onto its board produces significantly improved firm performance. I defined tainted ODs as ODs that are (were) senior executives at other firms where class action lawsuits were filed on behalf of an investor group that had suffered a financial loss in a stock. Especially, for the firms that appointed tainted OD as the chair of audit committee, their industry-adjusted return on assets is significantly increased by 6.8%. These results mean that under the presence of career concerns theory, tainted OD's history directly related to a previous securities class action lawsuit is a unique experience that modifies and disciplines their future behavior and eventually helps improve firm performance. Thus, through appointing tainted OD as an audit committee chair the firm might be able to reinforce the monitoring and transparency of its board, resulting in significantly better firm performance than any other control firms.