Does Director Discretion Protect Stakeholder Interests and Promote Long-Term Firm Value?

A Kellogg Work-in-Progress seminar with Faculty Fellow Martijn Cremers.

This paper analyzes the long-term value impact of enhanced director discretion to consider the interests of all stakeholders by exploiting the quasi-natural experiment provided by the staggered adoption of directors’ duties laws (also known as corporate constituency statutes) in 35 US states from 1984 to 2006. It shows that these laws result in an economically and statistically significant increase in firm value. That increase is stronger for larger and more complex firms, firms more exposed to endogenous uncertainty and with stronger stakeholder relationships. We test the bonding hypothesis that enhanced director discretion to protect stakeholder interests promotes long-term firm value by reducing a firm’s contracting costs. We also consider the view that enhanced director discretion helps internalize the externalities that firms create in incomplete markets, leading to more efficient production that benefits all stakeholders, including shareholders.