CEOs vs. Directors: Who Calls the Shots When Firms Underperform?

Abstract

We study the evolution of the board among firms experiencing a sudden negative performance shock and highlight the influence of the CEO in determining the changes. Over 40% of the original directors depart the board and boards become more independent in the three years following underperformance. The proportion of directors who work as consultants and of directors who are executives in other firms increases, while the proportion of directors in the financial industry, directors who hold multiple board seats, and directors representing large shareholders decreases. Influential CEOs are associated with smaller increases in board independence and less director turnover than less influential CEOs. Changes in the percentage of directors who are executives in other firms and directors who represent large shareholders are also negatively related to CEO influence. Together, these results show that influential CEOs continue to maintain their influence over the board following underperformance while less influential CEOs lose even more of their original influence. CEO influence and board changes are not related to subsequent changes in firm performance and the likelihood that firms will experience a financial restructuring event. We conclude that firms adjust their boards based on their own specific managerial and firm requirements.

Keywords: Boards, firm performance, bankruptcy, corporate governance, CEO power

JEL Classification: G31, G33, G34