How Do Corporate Boards Learn About CEO Ability? Evidence from Structural Estimation
45 Pages Posted: 12 Dec 2014
Date Written: November 2014
CEO ability is an important determinant of firm performance but is usually not directly observable. I use simulated method of moments (SMM) in order to estimate a dynamic model of learning about CEO ability from the firm’s stock market valuations, operating returns, and CEO turnover. This model features an information asymmetry between the firm’s board of directors and the stock market, as well as misalignment between the board and shareholders. I find that learning about CEO ability is influenced by the stock market’s public signal, the board’s private signal, and operating returns in a ratio of 2.3 : 2.1 : 1. When learning about CEO ability corporate boards rely mostly on public stock market information and inside information available only to the board, but are less concerned with accounting data.
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