Director Departure and Noncompliance With Securities Laws

Abstract

Research Question/Issue: This study investigates director departures surrounding the actual commencement of noncompliance events when public perception of the wrongdoing is less likely to exist. Research Findings/Insights: Using a manually constructed nonaccounting noncompliance dataset of the Securities and Exchange Commission’s enforcement actions and hand-collected information on directors’ status and characteristics, this study finds that firms not complying with securities laws experienced significantly higher unexpected director departures than control firms during the period in which the noncompliance began. Outside directors, in particular, tend to leave in the pre-noncompliance period but not in the post-noncompliance phase. The findings are robust across propensity score–matched tests, conditional logistic regression, and when controlling for CEO turnover. Further exploration of the characteristics of departing directors provides insights into the dynamics of the internal governance mechanism. It shows that directors with a background in an area of specialized expertise tend to leave noncompliant firms. The evidence also suggests that power struggles between departing directors and managers in noncompliant firms might contribute to director departure. Theoretical/Academic Implications: This study extends the literature aimed at unraveling internal governance mechanisms around firms’ negative events. Since there are several important points along the timeline of a negative event, providing evidence on director behavior around these points can offer deeper insights into internal governance mechanisms. Practitioner/Policy Implications: This study provides unique evidence that there is an abnormal departure rate of directors before the commencement of firms’ wrongdoings. This departure is consistent with explanations that directors with an information advantage from a special background are likely to foresee that problems or power struggles between directors and managers are likely to induce the departure of a director who is in a relatively weak position. The findings offer insights for policy makers, suggesting that regulators may need to reflect upon the shortcomings of the current governance system and how to hold management accountable, rather than putting heavy emphasis on developing doctrines for directors’ duties.