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We use the 2002 NYSE and NASDAQ listing requirements mandating firms have a majority of independent directors on the board as an exogenous shock to examine the interaction between internal and external governance. Relative to compliant firms, noncompliant firms significantly reduced exposure to three external governance mechanisms: the market for corporate control, shareholder activism, and credit markets, by adding antitakeover provisions, adopting officer and director protection provisions, and reducing debt levels, respectively. The results are stronger in firms with greater exposure to the relevant external governance mechanism. The evidence suggests that firms treat internal and external governance as substitutes.
