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

Abstract:     
Corporate governance disasters could often be averted questioned CEOs, demanded answers, and blown whistles. Work in social psychology, by Milgram and others, suggests humans have an innate predisposition to obey authority. This excessive subservience, here dubbed a "type II agency problem", explains directors' eerie submission. Rational explanations are reviewed, but behavioral explanations are shown to be more complete. Further behavioral studies reveal this predisposition to be disrupted by dissenting peers, conflicting authorities, and distant authorities. This suggests independent directors, non-executive chairs, and committees composed of independent directors and excluding CEOs might induce greater rationality and more considered ethics in corporate governance. Empirical evidence of this is scant. This may reflect measurement problems, for many apparently independent directors may have hidden financial or personal ties to CEOs. It might also reflect other behavioral considerations that reinforce agentic subservience to CEOs.

Number of Pages in PDF File: 27

Keywords: Corporate Governance, Behavioral Finance, Obedience, Milgram, Information Cascade

JEL Classification: G3, K22, C9

working papers series