Are outside directors who are active executives in other firms effective advisors and monitors? Evidence from executive compensation

Purpose This paper aims to examine the effect of advisory (ADVAE) and monitoring (MONAE) directors, who are active executives in other firms on executive compensation. Design/methodology/approach Using a comprehensive dataset of 10,925 firm-year observations of FTSE All-Share nonfinancial firms over a 20-year period (1999–2018), the study use ordinary least-squares (OLS) regression models. Robustness checks include the between-effects estimator, propensity score matching, lead-lag structure, tenure-weighted independent variables, adjusted compensation measures and alternative financial performance metrics. Findings The results reveal that MONAE are positively associated with executive compensation, including cash and noncash components, and negatively associated with future financial performance, supporting over boarding and social identity perspectives. Conversely, ADVAE exhibit no significant impact on these outcomes. Further analysis reveals that MONAE moderate the excess pay-future performance nexus, a role not observed for ADVAE. Practical implications The findings highlight the potential risks of appointing outside directors, who are distracted or homogeneous with the top management team to monitoring roles and support UK reforms limiting the external directorships of active executives. They do not suggest barring such directors from monitoring roles, but recommend limiting their number, particularly on critical monitoring committees. Originality/value This study contributes to the literature by disaggregating the roles of outside executive directors into advisory and monitoring functions, offering nuanced insights into their distinct impacts. Drawing on agency, social identity and resource dependency theoretical perspectives, it addresses inconsistencies in the existing literature regarding the effectiveness of these directors and challenges the prevailing assumption that increased monitoring intensity necessarily enhances board monitoring effectiveness.