What Matters More in Board Independence? Form or Substance?

Prior studies show uncertain associations between board independence and firm performance. We propose a novel measure of board independence and argue that influential CEO-directors (ICDs), those with higher compensation than the appointing firm’s CEO, are more independent of appointing firm’s top management. Controlling for conventional measures of board independence, we show that ICDs are effective monitors who help appointing firms by improving CEO pay-performance sensitivities. Through improved managerial incentives, ICDs have a significantly positive impact on long-term firm performance. In contrast, uninfluential CEO-directors are ineffective monitors whom presence on the board is either inconsequential or even detrimental to the firm.