Intrinsically-Motivated CEOs, Overbearing Boards, and Diversity in Corporate Governance

Abstract

We examine how a Board of Directors designs the CEO's compensation contract and the degree of Board oversight in an environment in which CEOs are intrinsically motivated, enjoy private benefits, and may disagree with their Boards over the value-maximizing choice of a project-related action. The Board's oversight has two inherently inseparable features: one is "objective policing" to reduce the likelihood that the CEO will invest in an inefficient project due to private benefits, and the other is involvement in "subjective decisionmaking" whereby the Board attempts to ensure that, conditional on investing in an efficient project, the action that it believes maximizes project value is chosen even if the CEO disagrees. We show that even when the Board's oversight has no explicit monitoring cost and provides an informative signal of the CEO's project and action choices, it is not generally optimal for the Board to choose the maximum oversight. Paradoxically, greater Board oversight can produce the opposite of its intended effect, inducing the CEO to be more inclined to engage in self-serving behavior. Moreover, a variety of different governance structures will be observed in equilibrium, each with its own governance oversight. Constraints on the CEO's compensation can lead the Board to precommit to low oversight in order to not appear overbearing and thus attract a CEO of high ability. Numerous additional empirical implications emerge from the analysis.

Keywords: Corporate Governance, Oversight, Intrinsic Motivation

JEL Classification: G30