Do Outside Directors Tell the Truth, the Whole Truth, and Nothing But the Truth When They Resign?

Abstract

This study examines the informativeness and credibility of independent directors’ stated reasons for resignation. Directors are privy to private information about the firm, and therefore may resign in anticipation of future underperformance to limit potential reputation damage. We posit that directors have an economic incentive not to disclose the true reason for their resignation in order to protect their existing equity ownership, business relationships, and future directorship opportunities. Consistent with these conjectures, we find that the likelihood of resignation increases with reputation and weak future performance. Moreover, resignations lacking unambiguous or verifiable reasons are associated with poor recent and future financial and operating performance. Investors and analysts appear to partially understand and respond to such misrepresentations, as evidenced by an immediate negative and economically significant market reaction and downward forecast revisions. Complementary factors such as positive concurrent operating results and richer information environment somewhat mitigate the negative reaction.