Do Locally-Based Independent Directors Reduce Corporate Misconduct?

We explore the influence of the localness of independent directors on Chinese listed firms' fraudulent and non-compliant practices. We are motivated by the dynamics between monitoring and favoritism—the moving parts driving the association between geographic proximity and monitoring outcomes. In our analysis of A-share listed firms in China between 2007 and 2013, we find that local independent directors at both the provincial and the city-levels reduce the frequency and magnitude of the misconduct by listed firms. Furthermore, the monitoring effect is stronger for independent directors who are in the same province/different city than those in the same province/same city, which suggests that while the monitoring effect of localness remains constant, the favoritism effect is stronger for independent directors who reside in the same city. We also find that political connections negatively moderate the effect of local independent directors' monitoring function, especially with non-state-owned firms. Data Availability: All data are available from public databases and annual reports of listed firms identified in the paper, except for the CSMAR data, which are available from the company upon request.