Advising and Monitoring CEOs: The Dual Role of Boards
49 Pages Posted: 22 Aug 2010
Date Written: August 16, 2010
The board of directors performs the dual role of monitoring and advising the firm’s management. At times it makes certain key decisions itself. We study the optimal board composition (of monitoring and advisory “types”) within a cheap-talk framework where the CEO and the board each may have private information about an impending investment decision, and their incentives are imperfectly aligned. When shareholders choose both the board composition and the allocation of decision rights between CEO and board, a non-monotonic relationship between CEO bias and board composition emerges. A key concern to practitioners and regulators is “CEO power”. Counter to conventional wisdom, we show that powerful CEOs who nominate board members themselves may in fact prefer a greater degree of monitoring intensity on the board than do shareholders. As a result, regulatory interventions (such as the Sarbanes-Oxley Act) that attempt to strengthen the monitoring role of boards, may in fact be harmful in precisely those cases where agency problems are the most severe. Lastly, CEOs may be able to entrench themselves by choosing “complex” projects involving greater information advantage. In response, shareholders may commit to an advisor-heavy board to preempt entrenchment.
Keywords: board of directors, corporate governance, CEO power, CEO entrenchment
JEL Classification: D82, G34, M40
Suggested Citation: Suggested Citation