Musa Subasi is Assistant Professor of Accounting and Information Assurance at the University of Maryland, College Park. This post is based on a recent paper by Professor Subasi; Ferhat Akbas, Associate Professor of Finance at the University of Illinois at Chicago; Rebecca N. Hann, Associate Professor & KPMG Faculty Fellow at the Robert H. Smith School of Business, University of Maryland; and M. Fikret Polat, a PhD Student in Accounting & Information Assurance at the Robert H. Smith School of Business, University of Maryland.
Like financial markets, director networks serve as a conduit of information exchange and managers may access a wealth of information from the network through their boards’ connections. In this paper, we address several questions. Do director networks improve managerial learning from financial markets? Does corporate governance affect the extent to which managers utilize the information advantage from their boards’ connections in their investment decisions? And, what types of director connections are more instrumental in preventing managers from basing their investment decisions on faulty price signals?
We explore these questions by studying the effect of director networks on the sensitivity of investment to noise in stock prices, which has been documented to be positive in prior research. We use the number of director connections to capture board connectedness. To capture the extent of managerial (mis)learning from stock prices, we use a Q-theory of investment framework and decompose stock prices into a non-fundamental component (noise) and its orthogonal component using mutual fund redemptions as an exogenous shock to stock prices.