Resignations Could Spell Trouble

Outside directors have incentives to resign to protect their reputation or avoid increased workload when they anticipate the firm will perform poorly or disclose adverse news.

In find no real surprise in the research of Fahlenbrach, Low, and Stulz who find strong support for the hypothesis that following surprise director departures, affected firms have stock performance, worse accounting performance, a greater likelihood of an extreme negative return, a greater likelihood of a restatement, and a greater likelihood of being sued by their shareholders.

Surprise departure of an outside director increases the probability of an earnings restatement by almost 20% and the probability of being named in a federal class action securities fraud lawsuit by 35%. The authors suggest analyzing the impact of different types of compensation schemes on directors’ incentives to quit to protect their reputation.
(The Dark Side of Outside Directors: Do They Quit When They are Most Needed?, March 1, 2010)

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