How Does Board Structure Affect Customer Concentration?

Previous research on corporate boards focuses on the interactions between the directors and the chief executive officers (CEOs) and ignores other stakeholders. We show both theoretically and empirically that board structure affects a firm's interaction with its major customers. In our model, a more independent board possesses less precise information, which encourages the CEO to undertake relation-specific investment with major customers. However, a more independent board is also more likely to reject the CEO's decision, making the CEO choose the safe project instead. To empirically test which of these two forces dominate, we use the Sarbanes-Oxley Act of 2002 as an exogenous shock that caused board structure to change. We find that higher board independence is associated with lower customer concentration (CC). In an average high CC firm, replacing one inside director with one independent director is associated with 5.97% less sales to all the major customers and 4.13% lower market-to-book ratio when compared to the controlled firm. The impact is particularly large when firm-specific information is difficult to acquire for independent directors. This paper is among the first to investigate how board structure affects business relations with major customers. We also provide new evidence on the board's real impact on firms' operating activities.