A recent study from a group of finance professors reinforces the rationale for director stock ownership guidelines. Based on analyzing 5,000+ companies from 2008 – 2021, the authors found that director equity is correlated with a lower likelihood of a stock price crash – but the strength of the correlation depends on the characteristics of the board and the company. Here are a few risks that directors who have “skin in the game” are likely to avoid:

1. Over-Investment

Prior studies have linked over-investment—particularly in low-return projects—to crash risk. When directors are inattentive, managers may engage in empire building or value-destroying acquisitions. We find that higher DEC is associated with significantly lower levels of abnormal investment, consistent with enhanced board oversight discouraging inefficient capital allocation.

2. Financial Misreporting

We use future financial restatements flagged as fraudulent (from the WRDS non-reliance dataset) as an indicator of opaque reporting. Firms with more equity-compensated directors are significantly less likely to restate their financials due to fraud, suggesting improved monitoring of accounting practices.

3. Bad News Hoarding

Delayed disclosure of adverse information is a central cause of crash risk. Using a standard event-study approach, we find that cumulative abnormal returns around earnings announcements are more negative when firms report bad news—especially when DEC is low. However, this stock price decline is significantly muted in firms with high DEC, indicating that bad news is more likely to be released in a timely and incremental fashion, rather than building up and triggering a crash.

Collectively, these findings support the enhanced monitoring view: DEC reduces managerial opportunism and strengthens governance.

There’s no one-size-fits-all. The analysis found that the benefits of director equity compensation were greatest at companies that had entrenched management, more opaque financial reporting, and transient institutional investor ownership – and when directors were well-qualified and not overcommitted. The data also seemed to show that the benefits of director equity ownership were most pronounced, and stock price crashes less likely, among boards that had a relatively higher proportion of women directors.

– Liz Dunshee