A recent stream of literature examines the determinants of interlocked boards and the monitoring effectiveness of boards with directors holding multiple directorships.
Recent research also examines the association between interlocked boards and CEO compensation.
Other papers have used the number of interlocked outside directors as a proxy for the effectiveness of board oversight in different contexts.
Following previous work (Hallock, 1997), we focus on interlocked directors that involve one inside director and one outside director since these types of interlocks are the most likely to compromise the monitoring effectiveness of boards.
Because we wish to compare the impact of interlocked boards as defined above to noninterlocked boards, we eliminate 330 firm-years involving other types of interlock (e.g., those involving two outside directors).
We next examine, in greater detail, the interlocked observations in our sample period.
Since any pair of interlocked directors may repeat from year to year if their directorships do not change, we also identify their initial occurrence in our sample period.
To provide evidence regarding whether interlocked directors are associated with weak monitoring, we examine the association between the presence of interlocked directors and firm performance.
This is an important control variable that enables us to distinguish between the effects of interlocked directors and "busy" directors.
The results may also explain why companies like Enron, Arthur Andersen, Global Crossing, and many Japanese and Asian firms that were heavily interlocked with their federal and local governments did not benefit from those relationships in the long term.
Thus, an important managerial implication of our study is that firms should appoint directors that are interlocked with firms in other spheres of the firm's business activities.
First, future research should consider finer-grained models that measure not only the size and scope of interlocks but also their quality (e.g., the kinds of directors and their backgrounds that are interlocked), the type of institutional investor (pension, mutual, insurance, and municipal funds have different investment horizons and rate of return objectives and therefore cannot be treated as homogenous) and variations in board composition, not just in terms of outsider ratios but also experience, professional background, and gender (see Daily et al.