Board Interlocks and Outside Directors’ Protection

We examine the role of outside directors’ interlocks in restoring directors’ indemnification protection in response to Delaware’s Schoon v. Troy Corp. The case, which permitted a board to retroactively alter indemnification and advancement-of-expenses arrangements for a former director, left directors vulnerable unless their firm acted to restore protection. Using a hand-collected data set, we find that a firm became more than twice as likely to adopt enhanced indemnification protection once a firm with which it shared an outside director adopted protection. Our results suggest that interlocks contribute to outside directors’ knowledge and bargaining power in the boardroom. Consistent with the bargaining-power hypothesis, we find that several measures of outside directors’ power are associated with a higher probability of responding: a large proportion of outside directors, a designated independent lead director, and, with marginal significance, more board meetings in executive session.

These results have legal and practical implications for corporate governance.