A Theory of Corporate Boards with Endogenous Information Collection, Optimal Compensation and Strategic Voting: When Do Independent Boards Dominate Rubberstamping Ones?

Abstract

This paper presents a model of the collective decision making of corporate boards. Each director collects costly private information and votes to maximize his welfare given his compensation. We derive optimal contracts that induce first-best outcomes for shareholders despite directors' incentive to free-ride on each others' information and votes. Our model highlights important frictions between information collection and information sharing, and between board accountability and independence. We identify conditions under which a rubber-stamping or captive board achieve higher shareholder value than an independent or active board and conditions under which the reverse is true. Our findings hold whether board decisions are made through majority, supermajority or unanimity voting rules and whether balloting is open or secret.

Keywords: corporate boards, corporate governance, executive compensation

JEL Classification: G34, L22