Forthcoming, Review of Financial Studies
65 Pages Posted: 29 Oct 2010 Last revised: 22 Apr 2014
Date Written: September 10, 2013
We argue that not all independent directors are equally effective in monitoring top management. Specifically, directors who are appointed by the CEO are likely to have stronger allegiance to the CEO and will be weaker monitors. To examine this hypothesis, we propose and empirically deploy two new measures of board composition. Co-option is the fraction of the board comprised of directors appointed after the sitting CEO assumed office. Consistent with Co-option serving to measure board capture, as Co-option increases board monitoring intensity decreases: turnover-performance sensitivity diminishes; pay level increases but without a commensurate increase in pay-performance sensitivity; and investment in hard assets increases. Further analysis suggests that even independent directors who are co-opted are less effective monitors. Non-Co-opted Independence –– the fraction of the board comprised of independent directors who were already on the board before the CEO assumed office –– has more explanatory power for monitoring effectiveness than the traditional measure of board independence.
Keywords: Corporate Governance, Board Co-Option, CEO Entrenchment, Board Composition
JEL Classification: G32, G34, K22
Suggested Citation: Suggested Citation