New regulations and corporate governance activists have called for more outside directors on boards and committees, yet existing research has failed to find convincing evidence that outside directors improve firm performance. This paper estimates the effect of outside directors using a new empirical strategy that controls for the well known endogeneity problem in board composition by focusing on firms that were required to increase the number of outside directors as a result of the Sarbanes- Oxley Act. We find that the effect of outside directors on performance depends on their cost of acquiring information: outside directors are effective when the cost of acquiring information is low and are ineffective when the cost of acquiring information is high. We also find that firms compose their boards as if they understand that outsider effectiveness varies with information costs.


Corporation and Enterprise Law | Law and Economics | Organizations

Date of this Version

January 2008