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Insular Decision-making in the Board Room : Why Boards Retain and Hire Sub-Standard CEOs

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  • Meg Sato

    (Australia-Japan Research Centre)

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    Abstract

    It is widely believed that corporate boards are overly reluctant to fire their CEOs. The conventional explanation for retaining a CEO regardless of his/her talent is that a CEO chooses the board members and has the power to fire them. However, very few studies have investigated how a new CEO is chosen. This paper explores an unexamined cause of board reluctance in removing a CEO : the incentive to minimize the leakage from the decision-makers future surplus. I argue that this same logic provides the theoretical explanation for how a new CEO is chosen for both voluntary and forced CEO replacements. I show that this incentive of the incumbent board and CEO often departs from the shareholders interest. In short, if the net surplus of the incumbent board and CEO is expected to be larger under an incumbent sub-standard CEO, or under an internal candidate rather than an external candidate, then they retain the incumbent sub-standard CEO or promote an internal CEO candidate, even though the expected corporate profit generated by appointing an external candidate is likely to have been greater.

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    File URL: http://saber.eaber.org/node/22884
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    Bibliographic Info

    Paper provided by East Asian Bureau of Economic Research in its series Microeconomics Working Papers with number 22884.

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    Date of creation: Jan 2009
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    Handle: RePEc:eab:microe:22884

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    Related research

    Keywords: CEO Succession Policy; Board Composition;

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    1. Adams, Renee & Hermalin, Benjamin E. & Weisbach, Michael S., 2009. "The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey," Working Paper Series 2008-21, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    2. Agrawal, Anup & Knoeber, Charles R., 1996. "Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 377-397, September.
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