Similarity Breeds Trust: Political Homophily and CEO-Board Communication

We find evidence that similarity of political views between the CEO and independent directors (“political homophily”) encourages the CEO to share adverse information with the board. Firms with higher political homophily have lower stock price crash risk, are more likely to divest previously acquired assets with poor performance, and write down loss-making assets. Greater political homophily also increases the profitability of independent directors’ insider trading and reduces the performance gap relative to CEOs’ insider trades. Furthermore, the effect of political homophily is complemented by strong external governance which prevents a friendly board from insulating the CEO following ex post negative outcomes. Our identification utilizes the exogenous variation in political beliefs associated with the entry of a conservative television network in local markets.