Can independent directors effectively monitor controlling shareholders after reappointment?

Abstract

The mandatory rotation of independent directors upon the expiration of their term is a key institutional design in China, aimed at safeguarding their independence and enhancing the effectiveness of their supervision. However, whether reappointing these directors after a “cooling-off period” following mandatory rotation undermines the effectiveness of supervision remains an open question. We investigate whether independent directors can effectively monitor tunneling activities after their reappointment. We find that their monitoring is less effective during their reappointment term than in their first term, reflected in a significant increase in related-party transactions with controlling shareholders. A mechanism test reveals that independent directors’ monitoring behavior is more passive during the reappointment term, as evidenced by less dissent and a lower likelihood of challenging proposals related to controlling shareholders. These effects are more pronounced when reappointed independent directors are less willing or able to supervise, or when the company’s internal and external governance environment is poor. Supervision also appears to be more effective if they are reappointed after a cooling-off period of more than three years. This paper extends research on the governance impact of reappointed independent directors and provides empirical evidence that can help to improve their post-term management practices.