Behavioral Finance in Corporate Governance - Independent Directors and Non-Executive Chairs

Abstract:     
Corporate governance disasters could often be averted had directors asked their CEOs questions, demanded answers, and blown whistles. Work in social psychology by Milgram (1974) and others shows human subjects to have an innate predisposition to obey legitimate authority. This may explain directors' eerily compliant behavior towards unrestrained CEOs. Other work reveals factors that weaken this disposition to include dissenting peers, conflicting authorities, and distant authorities. This suggests that independent directors, non-executive chairs, and committees composed of independent directors that meet without the CEO might induce greater rationality and more considered ethics in corporate governance. Empirical evidence of this is scant. This may reflect measurement problems, in that many apparently independent directors actually have financial or personal ties to their CEOs. It might also reflect other behavioral considerations that reinforce director subservience to CEOs.

Number of Pages in PDF File: 26

working papers series