Inside directors, board effectiveness, and shareholder wealth

Abstract

We investigate whether inside managers are added to corporate boards for efficiency or entrenchment purposes. Our examination of inside director appointments finds that the stock-market reaction to the announcement is significantly negative when inside directors own less than 5% of the firm's common stock, significantly positive when their ownership level is between 5% and 25%, and insignificantly different from zero when ownership exceeds 25%. These results suggest that the expected benefits of an inside director's expert knowledge clearly out weigh the expected costs of managerial entrenchment only when managerial and outside shareholder interests are closely aligned.