Board Dynamics: A Structural Investigation

48 Pages Posted: 28 Aug 2014

Date Written: August 27, 2014

Abstract

This paper studies how board structure changes with CEO characteristics. I estimate a structural model that endogenizes board structure, CEO firing, and firm performance. Adopting such an approach mitigates endogeneity concerns and allows for the exploration of some within-firm results that are difficult to document using regressions. I find a negative relation between board independence and CEO ability. This relation is strong when CEO ability is low, but it is weak on average. Further, when I restrict CEO ability to be the only CEO characteristic that can cause variation in board independence, the standard deviation of board independence in the simulated sample is less than 50% of its empirical counterpart. These results explain why the relation between board independence and CEO ability becomes insignificant in regression framework. Additionally, I find that appointing more outsiders only moderately improves the board's monitoring performance. The directors are unwilling to fire some low-ability CEOs because their private firing cost can be as large as $116 million on average. An outsider-dominated board reduces such a cost by less than 20%. Some low-ability CEOs are therefore able to keep their jobs even when the board comprises mostly of outsiders and board members hold a significant proportion of equity.

Keywords: Board of Directors, Corporate Governance, Structural Estimation

JEL Classification: G34

Suggested Citation

Lee, Wei-Ming, Board Dynamics: A Structural Investigation (August 27, 2014). Available at SSRN: https://ssrn.com/abstract=2487823 or http://dx.doi.org/10.2139/ssrn.2487823

Wei-Ming Lee (Contact Author)

University of Exeter ( email )

Streatham Court
Xfi Building, Rennes Dr.
Exeter, EX4 4JH
United Kingdom

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