Submitted to Management Science
Governance and CEO turnover:
Do something or do the right thing?*
Columbia University, 823 Uris Hall, New York NY 10027 firstname.lastname@example.org
Harvard University, Boston MA 02163, email@example.com
Harvard University, Boston MA 02163, firstname.lastname@example.org
Emory University, 1300 Clifton Road, Atlanta, GA 30322, email@example.com
We study how corporate governance aﬀects ﬁrm value through the decision of whether to ﬁre or retain the CEO. We present a model in which weak governance - which prevents shareholders from controlling the board - protects inferior CEOs from dismissal, while at the same time insulates the board from pressures by biased or uninformed shareholders. Whether stronger governance improves retain/replace decisions depends on which of these eﬀects dominates. We use our theoretical framework to assess the eﬀect of governance on the quality of ﬁring and hiring decisions using data on the CEO dismissals of large U.S. corporations during 1994-2007. Our ﬁndings are most consistent with a beneﬁcent eﬀect of weak governance on CEO dismissal decisions, suggesting that insulation from shareholder pressure may allow for better long-term decision-making.
From Adam Smith (1776) and Berle and Means (1932) to Hermalin and Weisbach (1998), economists have expressed concern about entrenched CEOs’ ability to pursue personal gain at the expense of shareholders. The prevailing belief is that ﬁrms risk value destruction by self-serving CEOs, if they are left unchecked by weak boards or weak shareholders. At the same time, many companies have actively chosen to weaken shareholders’ powers with the explicit aim of ensuring that long-term proﬁts are maximized. Most recently, Facebook, LinkedIn, and Groupon completed initial public oﬀerings (IPOs) with dual class share structures—with * We thank Ren´e Adams, Thomas Chemmanur, Bruce Greenwald, Steve Kaplan, Bengt Holmstrom, Vinnay Nair, e
Andrew Metric, Tano Santos and Michael Weisbach for useful discussions. We also thank participants at HBS, Sloan, UWO, Yale SOM, Berkeley Hass, Econometric Society 2005 World Congress, European Finance Association, the SIFR conference on Corporate Governance, and the 6th Maryland Finance Symposium. All errors are our own. 1
Fisman et al.: Do the right thing?
Article submitted to Management Science; manuscript no. MS-10-01142.R2
super-voting shares retained by insiders. In Google’s case, the company introduced a new class of nonvoting shares, saying, “outside pressures [from stockholders] too often tempt companies to sacriﬁce long term opportunities to meet quarterly market expectations.”1 Google’s concern about too much shareholders inﬂuence seems at odds with the traditional notion that entrenchment—the insulation of CEOs from shareholders—is bad for ﬁrms’ performance. In this paper, we incorporate both of these views into a theory of entrenchment that distinguishes between the ability of CEOs to control the board (the “CEO Protection” view) versus the board’s ability to ignore shareholders (the “Board Protection” view). The literature on entrenchment largely ignores this distinction, assuming that board dependence on the CEO and insulation from shareholders have the same eﬀect—protecting inferior CEOs. In our model, the CEO Protection and Board Protection views have diﬀering eﬀects on the ﬁrm. Speciﬁcally, we examine the quality of the board’s decision to retain or ﬁre CEOs. We focus on this decision because it one of the board’s primary functions, one that is made solely by the board, and one that lies at the heart of the debate on the costs of board entrenchment. We formally present and empirically examine a model that establishes distinct predictions for the CEO Protection and Board Protection views of entrenchment, and ﬁnd evidence that limiting shareholder power over boards—that...
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