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Finance Professors Look at Independent Directors and Risk Taking by Firms

In a newly published paper entitled, "Do Independence and Financial Expertise of the Board Matter for Risk Taking and Performance?" three professors of finance examine how board independence and the presence of financial experts among independent directors relate to risk taking and performance of commercial banks.  The study written by Bernadette A. Minton at  Ohio State University, Jérôme Taillard at Boston College, and Rohan Williamson at Georgetown University examines commercial bank risk taking data from the period from 2003 to 2008.  According to the paper's abstract:

During the recent financial crisis, financial expertise among independent directors of commercial banks is negatively related to changes in both firm value and cumulative stock returns. Furthermore, financial expertise is positively associated with risk-taking levels in the run-up to the crisis using both balance-sheet and market-based measures of risk. These results are not driven by powerful CEOs who select independent experts to rubber stamp strategies that satisfy their risk appetite. They are, however, consistent with independent directors with financial expertise recognizing the residual nature of shareholders' claim and supporting a heightened risk profile for their bank.

In essence, the paper concludes that board composition (i.e., the proportion of independent directors on a board) may be considered reliable proxy of how well a board deals with information provided by management.  In addition, the paper concludes that the presence of independent directors improves board monitoring of risk taking practices. For the most part, the data examined by the paper indicates that larger and more independent boards are associated with lower levels of risk taking.

The full text of the paper is available at:  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1661855