Endogeneity in CEO Power: A Survey and Experiment

Li, F., 2016, Endogeneity in CEO power: A survey and experiment, Investment Analysts Journal 45 (3): 149-162.

26 Pages Posted: 15 Mar 2011 Last revised: 22 Feb 2017

See all articles by Zhichuan Frank Li

Zhichuan Frank Li

University of Western Ontario - Ivey School of Business

Date Written: April 22, 2014

Abstract

The endogeneity problem has always been one, if not the only, obstacle to understanding the true relationship between different aspects of empirical corporate finance. Variables are typically endogenous, instruments are scarce, and causality relations are complicated. As the first attempt to summarize different econometric methods that are commonly used to address endogeneity concerns in the context of corporate governance, we explore the relation between CEO power and firm performance, as an experiment, to illustrate how these methods can be used to mitigate the endogeneity problem and by how much. After carefully dealing with the endogeneity issues, we find strong evidence that the true relationship between CEO power and subsequent firm performance is negative, suggesting CEOs are overpowered in some firms. Furthermore, we show that all the prevailing econometric remedies are generally effective in mitigating the endogeneity problem to some degree (i.e., to correct the sign from positive to negative), but quantitatively the effects vary considerably. Among all the remedies, GMM has the greatest correction effect on the bias, followed by instrumental variables, fixed effect models, lagged dependent variables, and the addition of more control variables. As for a combination of the methods, firm fixed effects, year fixed effects, and the addition of more meaningful control variables appear to work as well, even without a valid instrumental variable.

Keywords: Endogeneity Problem, CEO Power, Firm Performance, GMM, Fixed Effects, Instrument Variable, Lagged Dependent Variable

JEL Classification: G34, G32, C58, D23, J33

Suggested Citation

Li, Zhichuan Frank, Endogeneity in CEO Power: A Survey and Experiment (April 22, 2014). Li, F., 2016, Endogeneity in CEO power: A survey and experiment, Investment Analysts Journal 45 (3): 149-162.. Available at SSRN: https://ssrn.com/abstract=1785204 or http://dx.doi.org/10.2139/ssrn.1785204

Zhichuan Frank Li (Contact Author)

University of Western Ontario - Ivey School of Business ( email )

1151 Richmond Street North
London Ontario, Ontario N6A 3K7
Canada

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