Corporate Board Dynamics: Directors Voting for Directors

Abstract:     
I propose a dynamic model in which corporate directors perform firm tasks (such as monitoring management) and choose new directors. Previous literature has focused on the board composition that statically optimizes firm tasks. I incorporate features of these models and give directors the additional task of hiring new directors. This introduces an important dynamic el- ement: the board must consider both how new directors will perform in firm tasks and how new directors will try to change board composition in future hiring rounds. I find that the optimal board composition in the dynamic model differs from that of the static model. Additionally, lack of a commitment mechanism means directors do not always choose board compositions that maximize shareholder value. This creates an opportunity for regulation to benefit shareholders. In 2003, the NYSE and NASDAQ exchanges implemented two new rules. First, boards must be composed of a majority of outside directors. Second, director selection must be done by a nominating committee composed of outside directors. Additionally, the SEC is considering a proposal that grants shareholders additional powers in the director nominating process. I use the model to analytically and numerically investigate the effects of these new regulations on shareholder value. I find that the regulations may benefit shareholders of a firm in the dynamic environment, but never benefit shareholders in the static environment.

Number of Pages in PDF File: 40

Keywords: board of directors, voting for voters, corporate governance

JEL Classification: G3, L5, D7

working papers series