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Are All Independent Directors Equally Informed? Evidence Based on Their Trading Returns and Social Networks

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  • Ying Cao

    (School of Accountancy, The Chinese University of Hong Kong, Shatin, N.T., People's Republic of China)

  • Dan Dhaliwal

    (Eller College of Management, University of Arizona, Tucson, Arizona 85721; and Korea University Business School, Seoul 136-701, Korea)

  • Zengquan Li

    (School of Accounting, Shanghai University of Finance and Economics, 200433 Shanghai, People's Republic of China)

  • Yong George Yang

    (School of Accountancy, The Chinese University of Hong Kong, Shatin, N.T., People's Republic of China)

Abstract

We study the impact of social networks on the ability of independent directors to obtain private information from their firms' executives. We find that independent directors socially connected to their firms' senior executives earn significantly higher returns than unconnected independent directors in stock sales transactions. The network effect on independent directors' trading profitability is stronger in firms with higher information asymmetry and with more powerful executives. In addition, the trading returns of independent directors previously unconnected with firm executives increase after the arrival of a connected executive and drop after the connected executive leaves the firm. Moreover, the net stock sales by connected directors predict future negative news for up to three quarters. As a comparison, the trading returns of connected and unconnected independent directors do not differ significantly in stock purchases. Taken together, our results suggest that social connections help independent directors gain access to private bad news information from firms' senior executives. This paper was accepted by Mary Barth, accounting.

Suggested Citation

  • Ying Cao & Dan Dhaliwal & Zengquan Li & Yong George Yang, 2015. "Are All Independent Directors Equally Informed? Evidence Based on Their Trading Returns and Social Networks," Management Science, INFORMS, vol. 61(4), pages 795-813, April.
    • Handle: RePEc:inm:ormnsc:v:61:y:2015:i:4:p:795-813
    DOI: 10.1287/mnsc.2013.1892
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    References listed on IDEAS

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    Cited by:

    1. Francesca Franco & Christopher D. Ittner & Oktay Urcan, 2017. "Determinants and Trading Performance of Equity Deferrals by Corporate Outside Directors," Management Science, INFORMS, vol. 63(1), pages 114-138, January.
    2. Yangyang Chen & Jun Huang & Ting Li & Jeffrey Pittman, 2022. "It's a Small World: The Importance of Social Connections with Auditors to Mutual Fund Managers’ Portfolio Decisions," Journal of Accounting Research, Wiley Blackwell, vol. 60(3), pages 901-963, June.
    3. Mobbs, Shawn & Tan, Yongxian & Zhang, Shage, 2021. "Female directors: Why are some less informed than others?," Journal of Corporate Finance, Elsevier, vol. 68(C).
    4. Belaounia, Samia & Tao, Ran & Zhao, Hong, 2024. "Director foreign experience: Geographic specificity and value implication," International Review of Financial Analysis, Elsevier, vol. 91(C).
    5. Wenqing Wu & Kexin Yu & Chien-Chi Chu & Jie Zhou & Hong Xu & Sang-Bing Tsai, 2018. "Diffusion of Corporate Philanthropy in Social and Political Network Environments: Evidence from China," Sustainability, MDPI, vol. 10(6), pages 1-17, June.
    6. Erin H. Kao & Ho-Chuan Huang & Hung-Gay Fung & Xiaojian Liu, 2020. "Co-opted directors, gender diversity, and crash risk: evidence from China," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 461-500, August.
    7. Chao Jiang & Thomas R. Kubick & Mihail K. Miletkov & M. Babajide Wintoki, 2018. "Offshore Expertise for Onshore Companies: Director Connections to Island Tax Havens and Corporate Tax Policy," Management Science, INFORMS, vol. 64(7), pages 3241-3268, July.
    8. Khedmati, Mehdi & Sualihu, Mohammed Aminu & Yawson, Alfred, 2020. "CEO-director ties and labor investment efficiency," Journal of Corporate Finance, Elsevier, vol. 65(C).
    9. Hoitash, Udi & Mkrtchyan, Anahit, 2022. "Internal governance and outside directors’ connections to non-director executives," Journal of Accounting and Economics, Elsevier, vol. 73(1).
    10. Lamoreaux, Phillip T. & Litov, Lubomir P. & Mauler, Landon M., 2019. "lead Independent Directors: Good governance or window dressing?," Journal of Accounting Literature, Elsevier, vol. 43(C), pages 47-69.
    11. Seil Kim & Seungjoon Oh, 2024. "Outside directors’ insider trading around board meetings," Review of Accounting Studies, Springer, vol. 29(3), pages 2617-2649, September.
    12. Prabashi Dharmasiri, 2023. "Social connections, CEO turnover and corporate policy change," Australian Journal of Management, Australian School of Business, vol. 48(3), pages 567-595, August.
    13. Ting Luo & Jianqiao Yu, 2019. "Friends along supply chain and relationship-specific investments," Review of Quantitative Finance and Accounting, Springer, vol. 53(3), pages 895-931, October.
    14. Lin, Shu & Tian, Shu & Zheng, Lu, 2022. "Friend or foe: On a common shareholder relationship between mutual funds and public companies," Journal of Financial Markets, Elsevier, vol. 58(C).
    15. Alan D. Jagolinzer & David F. Larcker & Gaizka Ormazabal & Daniel J. Taylor, 2020. "Political Connections and the Informativeness of Insider Trades," Journal of Finance, American Finance Association, vol. 75(4), pages 1833-1876, August.
    16. Li, Siyuan & Qu, Tianshu Charlotte & Yu, Yingri Julia, 2022. "Outside director social network centrality and turnover before stock performance crash: A friend in need?," Journal of Corporate Finance, Elsevier, vol. 76(C).

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