Directors’ Incentives from Potential Regulatory Penalties: Evidence from their Voting

What makes independent directors perform their monitoring duty? One possible reason is that they are concerned about being sanctioned by regulators if they do not monitor sufficiently well. Using unique features of the Chinese financial market, we estimate the extent to which independent directors’ perceptions of the likelihood of receiving a regulatory penalty affect their monitoring. Our results suggest that they are more likely to vote against management after observing how another director in their board network received a regulatory penalty related to negligence. This effect is long-lasting and stronger if the observing and penalized directors share the same professional background or gender and if the observing director is at a firm that is more likely to be penalized. These results provide direct evidence suggesting that the possibility of receiving penalties is an important factor motivating directors.