In addition to potential legal and reputational liability, the outside directors of companies that become involved in corporate misconduct lawsuits risk losing opportunities to serve on other boards, according to a report released recently by The Conference Board (http://www.conference-board.org).
The report, Corporate Misconduct and the Market for Directorships, is the most recent installment of The Conference Board Director Notes series. It analyses the changes in directorships held by outside board members of 113 public companies involved in a shareholder class-action lawsuit alleging the misrepresentation of information to investors.
The study, analysing the period 1996-2005, tracks directorship changes for three years after the initiation of litigation to account for staggered director elections, and uses information from proxy statements to identify director turnover.
“With corporate board responsibilities increasing, most directors are preoccupied with the potential legal liability arising from performance of their duties,” said Matteo Tonello, Director of Corporate Governance Research at The Conference Board.
“This study sheds new light on the equally important reputational risks of having your name associated with a company investigated or sued for fraud or financial misrepresentation, and reinforces the need for sound risk management.” Within three years of litigation, 83.2 percent of outside directors remain on the board of the public company involved in the lawsuit, the study found.
Related research shows that outside directors in firms involved in litigation do not appear to turn over any more frequently than the average among all outside directors.
However, outside directors whose companies are involved in litigation appear to experience reduced opportunities to serve on other companies’ boards.
The average number of board seats held by these individuals at other companies drops from 0.95 in the year prior to the litigation to 0.47 three years after the suit is filed. More specifically, within three years:
96.3 percent of directors who hold one board position in addition to the seat on the sued firm’s board lose the additional directorship.
79.2 percent of directors who hold two other board positions lose both other directorships.
48.6 percent of directors who hold three or more other board positions lose all directorships.
“For these reasons, the due diligence performed by directors on current and prospective board positions should extend not only to legal liability exposure but also to the possibility of losing valuable opportunities for board membership at other firms,” says Jason Schloetzer, Assistant Professor of Accounting at Georgetown University’s McDonough School of Business and author of The Conference Board report.
“In the current litigation environment, it is particularly important for the board to demonstrate to shareholders (and the judicial system) that any failure to prevent or discover corporate misconduct took place in spite of the rigorous performance by the board of its oversight duties, including the establishment of a state-of-the-art compliance program.”