Independent Director And Firm Value

The original intention of independent director system was to solve the agency problem in the modern corporate system. In modern corporate system, the separation of decision control and corporate ownership leads to the opportunistic behavior of management, causing the insider control and moral hazard, which raises the operating cost and harms the stockholder’s equity. The key point of solving the problem is to maintain the independence of board, so the independent director system was born. The independent director system, which is the important internal mechanism in the board, is aiming at reducing the operating cost generated from corporate governance. Independent directors play a critical role to protect stockholder’s interest as they are independent to the firm. They are expected to question, even criticize the management as well as take the responsibility of sending the bad signal of the firm to the outsiders and warning management about their improper behavior, when the firm is in trouble. Meanwhile, as the expert in their own fields, independent director usually has good education background, abundant operating and managerial experience, and broad social relations. Thus, they can not only give their suggestions according to their knowledge and experience, but also they may offer many opportunities for the firm because of their social relations, as a result it can increase stockholder’s wealth. Based on these, independent directors play a very positive role in firms.The independent director system has been implemented for 10 years since 2001. The main purpose of the implementation of independent director system is to increase the board’s independence, which can diminish the largest shareholders controlling the board in order to improve the effectiveness of board’s decision and protect the benefit of all stockholders. But the effectiveness of the system in China is far under people’s expectation. In practice, the independent director system doesn’t play its function, and independent directors are called "vase", even some of them becoming the accomplice of the listed companies. At the same time, there is increasing number of directors resigning from the company. As a result, people start to thinking about the validity of the system.The study of the validity of the independent director system is to analyze whether the directors have value and contribution to listed companies. As so far, many literatures have concerned about the value of independent directors in many aspects, but these literatures only focused on the firm side, ignoring to consider this question standing from the market. Instead of standing from the firm side, this paper focuses on the market aspect to study the validity of the independent director system. This paper uses the resignation announcement of independent directors as research samples to analyze the market reaction to this event which illustrates whether directors are valuable to companies. Besides this, it also investigates the factors which influence the market reactions to see which kinds of director’s resignation are bad to the firm and which are good for the firm.This paper is organized as following:Chapter 1 is the introduction. This chapter describes the background and sense of this study, the main research method and content as well as the possible innovation.Chapter 2 is the literature review related to the topic of independent directors. In this chapter, the paper firstly reviews the prior research about the relation between independent directors and firm value which include three aspects as following:the monitoring function of independent directors, the assistant function of improving the firm’s performance and the protection function of minority shareholder’s interest. Secondly, this paper reviews the literatures about the turnover of independent directors, which focuses on the reason for turnover and the market reaction. From the literature review, there is only limited number of papers about the resignation of independent directors, and there’s no research considering about the influenced factors. So this study further enriches the research on the topic of independent directors.Chapter 3 analyzes the market reaction to independent director resignation and the influenced factors theoretically and develops the hypothesis of the paper. Above all, this paper uses the Principal-Agent Theory to explain the existence of independent director system, and analyzes the resignation behavior by using agency cost. Then, this paper explains the reason that the market would react to the resignation event by using Efficient Market Hypothesis and Signaling Theory. Finally, this paper develops the hypothesis after the analysis of the influenced factors which includes resignation reasons, personal characteristics of independent directors and the firm characteristics.Chapter 4 describes the design of empirical research. This paper uses the event study and multivariate regression to test the hypothesis. First, this paper uses the date of resignation announcements as the event date, and calculates the cumulative abnormal return for an 11-day period around the announcement day (from day-5 to day+5) to see market reaction to the resignation event. Second, this paper sets up the multivariate regression model by defining the CAR(-1,1) as the dependent variable, and the resignation reason, personal characteristics of independent directors and the firm characteristics as the independent variables. This model is to test the factors which influence the market reaction. Third, this part describes the sample selection process.Chapter 5 reports the empirical result. At the beginning, descriptive statistic is adopted to describe the 166 resignation announcements of listed companies from 2007-2009, which includes 141 listed firms and 179 independent directors. Then, the paper reports the market reaction to independent director resignation. The CAR values are all negative during the whole event period, and the CAR(-5,+5) drops 2.21%at the significance of 5%. This result states that the market takes the negative response to independent director resignation, which illustrates that the independent directors are valuable to listed companies. Lastly, the chapter reports the empirical result of multivariate regression, which illustrates that the market reaction is significantly associated with director’s age, director’s education degree, professional background and non-accounting financial background. Also, whether the company was punished and the independence of board has significant influence on the market reaction.Chapter 6 is the research results and policy suggestion. This section summarizes the research results in line with the empirical research, and gives the policy suggestions according to the research results. Besides, this section also states the limitation of the paper and further directions.The contribution of this paper lies in the following:First, this paper tests how the resignation of independent director affects the firm value. Majority of prior papers about independent director resignation focus on the reason of resignation and the economic consequences, but this paper empirically studied the market reaction to the event, which enriches the literatures about independent director resignation. Second, this paper studies the validity of independent director system from the market side. Prior researches focus on the validity of the system from the firm side, ignoring the market. So this paper tests the validity of the system standing from the market. Third, this paper tests the factors which influence the market reaction. This paper analyzes the resignation reason, personal characteristics of independent directors and the firm characteristics to see the market judgment of different kinds of independent directors.