Motivated by agency theory, we explore the effect of co-opted directors, i.e. directors appointed after the incumbent CEO assumes office, on corporate risk taking. Our results show that a higher proportion of co-opted directors on the board leads to significantly higher corporate risktaking, as reflected by the substantially higher volatility in stock returns and a higher standard deviation of Tobin'q. The evidence is consistent with the notion that co-opted directors represent a weakened governance mechanism that allows managers to take more risk. Additional tests show that endogeneity is unlikely, including a fixed-effects analysis, an instrumental-variable analysis, propensity score matching, and an analysis where we exploit the Sarbanes-Oxley Act as an exogenous regulatory shock that raises board co-option. Crucially, our evidence shows that board co-option can explain the extent of corporate risk-taking much better than does board independence, which has been the dominant measure of board quality in the literature.
JEL Classification: G32, G34
Keywords: co-opted directors, co-option, risk-taking, agency theory, corporate governance, board of directors
