The Labor Market for Directors and Externalities in Corporate Governance

This paper studies how directors\u27 reputational concerns affect board structure, corporate governance, and firm value. In our setting, directors affect their firms\u27 governance, and governance in turn affects firms\u27 demand for new directors. Whether the labor market rewards a shareholder-friendly or management-friendly reputation is determined in equilibrium and depends on aggregate governance. We show that directors\u27 desire to be invited to other boards creates strategic complementarity of corporate governance across firms. Directors\u27 reputational concerns amplify the governance system: strong systems become stronger and weak systems become weaker. We derive implications for multiple directorships, board size, transparency, and board independence