Who monitors the monitor? The use of special committees by target firms in corporate takeovers

This paper extends the corporate governance literature such as Alchian and Demsetz (1972) by analyzing the use of special committees of disinterested directors by target firms during corporate takeovers. Our sample spans post Sarbanes–Oxley from 2003 through 2007, under which boards of directors are subject to increased scrutiny and additional regulatory mandates. This period is also characterized by a high level of management buyout activity that can exacerbate conflicts. Our results show that special committee use is positively related to conflicts and negatively related to factors and situations where insider knowledge is particularly valuable. Moreover, the propensity to form a committee is negatively related to the board's overall independence; hence special committees substitute for the monitoring not found in the overall board composition. Special committees, on average, are formed well in advance of the merger agreement, employ additional financial advisors, and are more likely to run an auction process. Target returns in deals with special committees are no different than deals without special committees. The evidence indicates that special committees enable target boards to adapt to situational conflicts, which helps explain when independent directors matter for corporate governance.