Board Independence and Competence

33 Pages Posted: 23 Jul 2007 Last revised: 13 Oct 2014

See all articles by Alexander F. Wagner

Alexander F. Wagner

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swiss Finance Institute

Date Written: 2011

Abstract

This paper analyzes board independence and competence as distinct, but inextricably linked aspects of board effectiveness. Competent directors add shareholder value because they have better information about the quality of projects. While a CEO cares about shareholder value, he also wants his board to behave loyally to him by agreeing to projects that give him private benefits. Because many aspects of the CEO-board relationship are not contractible, the paper studies a model of relational contracts, a tool that has hitherto been rarely used in work on corporate governance. The analysis reveals a tradeoff: Inefficient loyalty is endogenously easier to obtain from a less competent board. The implied conflict of interest between shareholders and the CEO is particularly pronounced in difficult times. Fortunately, the tradeoff does not arise with respect to efficient loyalty. Several empirical predictions flow from the model, some of which explain existing empirical facts while others are new.

Keywords: Boards, Corporate Governance, Relational Contracts

JEL Classification: D23, G34, M50

Suggested Citation

Wagner, Alexander F., Board Independence and Competence (2011). Journal of Financial Intermediation, Vol. 20 (No. 1), p. 71-93, 2011, Swiss Finance Institute Research Paper No. 07-17, Available at SSRN: https://ssrn.com/abstract=1001206

Alexander F. Wagner (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Swiss Finance Institute ( email )

Switzerland

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