| Monitoring by outside directors is a governance mechanism that can alleviate the agency problem between managers and shareholders. Outsiders would be reluctant to serve on the board due to potential monetary liability, adverse reputational impacts and nuisance costs arising from shareholder litigation, especially in the face of frivolous claims. To attract and retain outside directors, a firm can choose to adopt a "limited liability provision" (LLP) to limit outside directors' fiduciary liability. In this thesis, I examine evidence for links between LLPs and (1) willingness of people to serve as directors; and (2) effectiveness of outside directors in performing their duties expected by shareholders.; Adoption of LLPs clustered in a period immediately following the mid-1980s Director and Officer insurance crisis. It is often said that during this period, outside directors shied away from serving on corporate boards. I show that economic factors closely linked to litigation risk appear to explain both the director outflow firms experienced during the crisis and the decision to adopt LLPs in a consistent fashion. Moreover, for utilities and financial firms, which had a tough time retaining outside directors during the insurance crisis, the decline in the number of outside directors stopped after LLPs were adopted.; Adoption of LLPs seems to have implications for subsequent conduct of outside directors in areas that are frequent targets of shareholder litigation against boards. Specifically, I find that the existence of LLPs is associated with opt-ins of more additional takeover defenses, higher managerial compensation and lower earnings quality. In contrast, adoption of LLPs is not linked to the pay-for-performance sensitivity of managerial compensation. |
