59 Pages Posted: 11 Dec 2011
Date Written: December 10, 2011
When regulation forces a board to become more independent than endogenously determined, the CEO may counteract by strengthening connectedness with other key players governing the firm. We find the independent board regulation triggered an increase in the fraction of top-executives appointed (FTA) during the incumbent CEO’s tenure, with the newly appointed executives showing more pre-existing network ties to the CEO. The closer connectedness seems to weaken the regulatory effect. When the regulation is binding in FTA — i.e., firms have little room to increase FTA, CEO compensation becomes lower, CEO pay becomes more sensitive to performance, forced CEO turnover becomes more likely when performance suffers, and Tobin’s Q increases. When firms have sufficient room to increase FTA to counter the regulation, we find the opposite — higher CEO compensation, lower CEO pay-for-performance sensitivity, lower forced CEO turnover-performance sensitivity, and lower Q. For these firms, the regulation leads to CEO entrenchment in executive suites, weakening monitoring and lowering shareholder value.
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