Local Director Talent and Board Governance

This paper examines the effects of director labor markets at firm headquarter locations on board governance. We argue that firms can implement better board governance by drawing on local director talent when a larger pool of prospective directors (officers and directors of same-industry firms, financial institutions, and universities) is located near the firm. We find that firms located near large pools of prospective directors have a higher percentage of outside directors and directors with executive expertise on the board. Firms located closer to financial institutions and universities attract a higher percentage of directors with financial and academic expertise, respectively. The dependence of board governance on local director labor markets is greatest for less established firms (small size, short history, low product market share, no institutional blockholder). With the adoption of Sarbanes Oxley and exchange governance requirements, firms appear to have expanded the search for outside directors beyond local director labor markets. Based on our empirical evidence, we formulate an instrument for board composition and use it in a two-stage setting to reexamine the relation between governance and firm value with correction for endogeneity. JEL: G30, G34