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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)

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.

Suggested Citation

  • Meg Sato, 2009. "Insular Decision-making in the Board Room : Why Boards Retain and Hire Sub-Standard CEOs," Microeconomics Working Papers 22884, East Asian Bureau of Economic Research.
    • Handle: RePEc:eab:microe:22884
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    References listed on IDEAS

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    1. Renee B. Adams & Benjamin E. Hermalin & Michael S. Weisbach, 2010. "The Role of Boards of Directors in Corporate Governance: A Conceptual Framework and Survey," Journal of Economic Literature, American Economic Association, vol. 48(1), pages 58-107, March.
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    7. Anup Agrawal & Charles R. Knoeber, "undated". "Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders (Revision of 29-94)," Rodney L. White Center for Financial Research Working Papers 08-96, Wharton School Rodney L. White Center for Financial Research.
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    9. Anup Agrawal & Charles R. Knoeber, "undated". "Firm Performance and Mechanisms to Control Agency Problems between Managers and Shareholders (Revision of 29-94)," Rodney L. White Center for Financial Research Working Papers 8-96, Wharton School Rodney L. White Center for Financial Research.
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    Cited by:

    1. Meg Sato, 2010. "Board's Monitoring and Retention of Sub-standard and Powerless CEOs," CIRJE F-Series CIRJE-F-711, CIRJE, Faculty of Economics, University of Tokyo.

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    More about this item

    Keywords

    CEO Succession Policy; Board Composition;

    JEL classification:

    • D79 - Microeconomics - - Analysis of Collective Decision-Making - - - Other
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • L29 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Other
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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