The Signals Outside Directors Send to Foreign Investors: Evidence from Korea

• Author: Mooweon Rhee,Ji‐Hwan Lee
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00663.x
• Date: 01 January 2008
• Published date: 01 January 2008

The Signals Outside Directors Send to Foreign

Investors: Evidence from Korea

Mooweon Rhee and Ji-Hwan Lee

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study explores a signaling role of the demographic composition of a f‌irm’s outside director

by examining how the composition inf‌luences the growth of foreigners’ investment in the f‌irm.

Research Findings/Insights: Using archival data from a panel sample of 96 large Korean f‌irms between 2000 and 2003, our

analysis shows that the growth of foreign ownership is positively affected if a higher proportion of outside directors hold

advanced foreign degrees, if a higher proportion of outside directors have former or current aff‌iliations with governmental

organizations, or if a higher proportion of outside directors have job experience in the same industry.

Theoretical/Academic Implications: Our theoretical perspective and supportive f‌indings suggest that the role of outside

directors is not conf‌ined to implementing the tasks stipulated as a corporategovernance mechanism; they also can be signals

that inform a market audience (foreign investors in our study) of the extent to which outside directors may provide a f‌irm

with a knowledge base, social status, and decision control.

Practitioner/Policy Implications: This study suggests several practical implications, prompting growing interest in the role

of outside directors as one of the most effective vehicles for improving corporate governance and symbolic management. In

addition, it offers insights to policy makers interested in establishing and updatingguidelines that inform f‌irms of desirable

board composition according to their strategic demands.

Keywords: Board composition, outside directors, Korea

INTRODUCTION

Prior studies have widely demonstrated (see Forbes and

Milliken, 1999, for an extensive review) that the demo-

graphic characteristics of a board of directors are a main

corporate governance mechanism inf‌luencing f‌irm behavior

and performance, such as investment decision (Kosnik,

1990), f‌irm valuation (Sanders and Boivie, 2004) and survival

(Daily and Dalton, 1994). In particular, recent research

has shown that directors have a signaling role when

stakeholders facesignif‌icant information asymmetry and the

associated risk of adverse selection and moral hazard. For

example, as stakeholders have limited information about

young f‌irms, they tend to judge the f‌irms by using observ-

able secondary information sources, including the demo-

graphic composition of board members (Deutsch and Ross,

2003; Sanders and Boivie, 2004).

In this paper, we suggest that information asymmetry is

also very problematic for foreign investors, because they

have less knowledge than domestic investors of local f‌irms’

operations and performance, as well as the country’s eco-

nomic environment (Cooper and Kaplanis, 1994; Dvorak,

2005; Stulz, 2005). This information disadvantage facing

foreign investors often leads to a difference in the pattern of

investment decision between domestic and foreign inves-

tors when they purchase the assets of local f‌irms (Brennan

and Cao, 1997; Kang and Stulz, 1997). Thus, it is possible to

suspect that more visible secondary indicators, such as

board members, also convey valuable information to foreign

investors. By investigating a sample of large public Korean

f‌irms from 2000 to 2003, this paper examines how the demo-

graphic composition of outside (or independent, non-

executive) directors sends a signal to foreign investors and,

consequently, affects the growth of their investment in local

f‌irms. Since the 1997–1998 f‌inancial crisis in Korea, all

Korean public f‌irms have been mandated to appoint a

minimum proportion of outside directors. While there is

heated debate over the rationale and legitimacy underlying

Korea’s economic reform, triggered by the f‌inancial crisis

*Address for correspondence: Shidler College of Business, University of Hawaii,2404

Maile Way, Honolulu, HI 96822. Tel: (808) 956-7610; Fax: (808) 956-2774; E-mail:

mooweon@hawaii.edu

THE SIGNALS OUTSIDE DIRECTORS SEND TO FOREIGN INVESTORS 41

Volume 16 Number 1 January 2008

© 2008 TheAuthors

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00663.x