The Effect of Informed Outside Directors on Investment Efficiency

Purpose – This study examines whether a firm’s investment efficiency is impacted by having an outside director who experiences investment efficiency at one of his/her other board seats. Methodology – Archival data is used to examine the research question. Findings – The results indicate that firms have higher levels of investment efficiency when they have an outside director who also sits on the board of another firm that has high investment efficiency. The result is most prevalent for the subsample of firms with a powerful CEO or with low information quality. Implications – An implication of this finding is that boards may look to the investment-related experiences that a director has through his/her other board service when deciding to add a new director. Moreover, the results imply that firms will know to look for these informed directors when they have information problems or a powerful CEO. Originality/Value – Investments require a firm to determine how it will allocate resources. Such important decisions require management to obtain the approval of the board of directors. This paper reveals that the investment-related experience that the directors obtain from their other board service is associated with efficient investment outcomes at the home firm.