Do Locally-Based Independent Directors Reduce Corporate Misconduct?

This paper explores the influence of geographic, social and cultural proximity of independent directors on reducing Chinese listed firms' fraudulent and noncompliant practices. Our choice of using local versus non-local independent directors as a focus of study is motivated by the relevance of geographic proximity in the prior literature on auditing, analysts' reporting, and institutional investing. Through the analyses of A-share listed firms in China between 2007 and 2013, we find that local independent directors reduce both the frequency and magnitude of the misconduct in listed firms. Furthermore, we find that political connections of independent directors reduce the effect of local independent directors' monitoring function, whereas the higher ratio of female independent directors enhances the monitoring effect. Our findings have the following policy implications: 1) geographic, social and cultural proximity should be considered when hiring independent directors because local directors have the potential to improve corporate governance; 2) political connections should be controlled in order to limit their negative effect on the performance of independent directors; 3) Gender diversity should be promoted when hiring local independent directors. We contribute to the literature on corporate governance by introducing the relevance of geographic, social and cultural proximity to corporate misconduct through corporate governance and highlighting the moderating effect of political connections and gender diversity