This study examines the role of “Professional Directors” and their association with the quality of monitoring outcomes proxied by investment efficiency. “Professional Directors” are board members with no employment outside of serving as independent directors.
We collect data on directors on the board at the fiscal year-end from BoardEx from 2001 to 2019 with a sample of US publicly listed firms. We follow Richardson (2006) to measure the magnitude of abnormal investment, including overinvestment and underinvestment and use these to define investment efficiency.
We find professional directors improve investing efficiency, primarily by reducing overinvestment. Professional directors may generate higher monitoring quality through their financial expertise and CEO experience, making them effective in monitoring investment efficiency.
Our study suggests that a professional board enhances monitoring and advising effectiveness in the face of significant regulatory pressure to increase board diversity.
We use two perspectives: (1) the difference in the proxy variables of monitoring effectiveness and (2) the influence of the background of professional directors, to reasonably explain this challenge. We resolve the puzzle of the inconsistent evidence on the effectiveness of professional directors in the literature.
