How CEO-Friendly Should Boards With Limited Attention Be?
53 Pages Posted: 8 Dec 2020 Last revised: 24 Nov 2021
Date Written: February 13, 2020
A revised version of this paper, titled "Board bias, information, and investment efficiency," is available here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3965147
A CEO who is an empire-builder reports information about an investment opportunity ("project"). Before approving or rejecting the project, a board of directors decides whether and how much additional information to collect, i.e., whether to remain rationally inattentive. We show that the CEO prepares and communicates a report that is just sufficiently precise so as to persuade the board not to learn any additional information and to approve some value-destroying projects (type-I error). The informativeness of the report is increasing in the misalignment of interests between the board and the CEO. Because more informative reports reduce the probability of approval error, the shareholders may optimally assemble a board that is "unfriendly" to the CEO. Our model predicts that (i) board-dependence regulations lead to decrease in corporate investments but an increase in return to shareholders; (ii) the return on investment is lower in companies with busy directors operating in less mature industries; (iii) the conflict of interest between boards and CEOs is either mild or moderately strong and the likelihood of strong conflict is lower in companies with busy directors and companies operating in less mature industries or industries with attractive outside opportunities for directors.
Keywords: Bayesian persuasion, rational inattention, empire building, board of directors, friendly boards, alignment of interests
JEL Classification: D71, D72, D81, D82, D83, G34
Suggested Citation: Suggested Citation