Advising and Monitoring CEOs: The Dual Role of Boards
Coauthor(s): Xiaojing Meng.
The board of directors performs the dual role of monitoring and advising the firm's management, and at times makes certain key decisions itself. We study the optimal board composition (of monitoring and advisory "types") within a cheap-talk framework
where the CEO and the board each may have private information about an impending
investment decision, and their incentives are imperfectly aligned. When shareholders
choose both the board composition and the allocation of decision rights between CEO
and board, a non-monotonic relationship between CEO bias and board composition
emerges. Counter to conventional wisdom, we show that powerful CEOs who nominate
board members themselves may in fact prefer a greater degree of monitoring
intensity on the board than the shareholders do. As a result, regulatory interventions
(such as the Sarbanes-Oxley Act) that attempt to strengthen the compliance role of
boards, will in fact be harmful in precisely those cases where agency problems are the
most severe. Lastly, CEOs may be able to entrench themselves by choosing "complex" projects involving greater information advantage. In response to the threat of
CEO entrenchment, shareholders may commit to a board composed of mostly advisory
Source: Working Paper
Baldenius, Tim, Nahum Melumad, and Xiaojing Meng. "Advising and Monitoring CEOs: The Dual Role of Boards." Working Paper, Columbia Business School, May 2010.