The Effect of an Independent Blockholder on the Board of Directors

Abstract

Recent papers have explored the direct impact of blockholders and boards on the managerial discretion of the CEO. This essay extends that line of research to examine the impact of blockholders on corporate boards. The problem driving the analysis is a CEO who plans to divert project resources for personal benefit. If successful, he will provide private benefits to insiders who support the diversion. Board insiders must decide whether or not to reveal this to outside board members and vote against the CEO's proposed project implementation. I find that, in the absence of a blockholder, the success of the diversion effort strictly depends on the size of the private benefit to insiders. By contrast, the presence of the blockholder can increase or decrease the willingness of insiders to vote against the CEO, to the point of precluding a rational CEO from even attempting diversion.