Director busyness and internal control weaknesses : evidence from a natural experiment

Abstract

This paper investigates the effects of multiple directorships on corporate internal control quality. By exploiting a natural experiment that introduces exogenous changes in board seats held by corporate directors, I find that reductions in directorships help mitigate firms’ internal control weaknesses. Cross-sectional analyses reveal that the main effects of multiple directorships on internal control quality channel through directors’ marginal time value, independent status, as well as board memberships. As a direct manifestation of internal control quality, I also document significant improvements in financial reporting quality as evidenced by a lower probability of accounting misstatements. These findings are robust to a battery of additional tests, including alternative model specifications, matched sample analyses, as well as competing explanations. Overall, this paper examines a theoretically ambiguous and empirically underexplored relation between multiple directorships and internal control quality, and finds causal evidence consistent with the director busyness hypothesis that multiple directorships adversely impair board governance effectiveness in internal control over financial reporting.