The Dual Role of Corporate Boards as Advisors and Monitors of Management: Theory and Evidence
56 Pages Posted: 16 Nov 2000
This paper analyzes the consequences of the board's dual role as an advisor as well as a monitor of management in the context of both a sole board system such as in the United States and the dual board system such as in various countries in Europe. As a result of this dual role the manager in a sole board system faces a tradeoff concerning the amount of information he discloses to the board. On the one hand if he reveals his information he gets better advice. On the other hand the board may change its opinion of his ability on the basis of his information. The model shows that the board may choose to pre-commit to reduce its monitoring of the manager in order to encourage the manager to share his information. I derive implications for the optimal monitoring intensity of the board as a function of managerial ownership and the manager's career concerns and test them in a cross section of Fortune 500 firms. The empirical evidence is consistent with the model's prediction that monitoring first decreases and then increases as ownership and tenure increase.
When the two roles of the board are separated, the manager does not face the same tradeoff in the provision of information. Therefore, an extension of the model shows that in certain situations it is better to separate the board's roles as advisor and monitor rather than combine them. This has implications for the choice of a dual board system over a sole board system and thus for cross-country variation in governance.
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