What Do Outside Directors Know? Evidence From Outsider Trading
Sarbanes-Oxley and other regulatory reform have advocated
to put more outsiders on the board. The rationale of this
measure is that outsiders are more independent, while a potential
drawback is that they might not know enough about the firm to be
effective monitors. Having information about the firm is a necassary
condition to be an effective monitor. This paper investigates whether
outside directors have information about the firm and its conditions.
Using a comprehensive sample of executives' and board of
directors' transactions from 1986 to 2003 in U.S. companies, we
compare the trading profits of three types of individuals: (i)
insiders (executives of the firm), (ii) non executive directors
who are large blockholders, and (iii) directors who are neither
employees of the firm, nor large blockholders (outside directors).
Insiders and outside directors earn higher abnormal returns than
the market. Insiders generally perform better than outsiders in
purchases transactions. These results suggest that outside
directors do have substantial inside information about the firm,
even though they know less than the executives. We also find that
in better governed firms the difference in performance between
outsiders' and insiders' returns is lower, suggesting that firms
with better governance structure may have better mechanism in
place that allows outsiders to receive more information
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