Directors’ Bankruptcy Experience and Financial Reporting Choices

We identify directors that experience a corporate bankruptcy and examine how this professional experience affects monitoring at the other firms where they concurrently sit on the board. Using a sample of US directors interlocked with firms that file for bankruptcy, we find that directors have a greater tolerance for real earnings management after a low-cost bankruptcy experience. This effect is stronger for independent directors and those who sit on the audit committee, consistent with a ratification and monitoring explanation. We do not find evidence consistent with the competing hypotheses that bankruptcy leads to directors’ distraction or incentivizes efficient cost-cutting strategies. We contribute to the research on the influence of directors’ corporate experience over corporate outcomes, by providing evidence suggesting that surviving a bankruptcy relatively unscathed lowers directors’ perception of the severity of distress costs, with negative consequences for decision control.

Recommended citation: Irina Gazizova and Beatriz Garcia Osma
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