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Behavioral Finance in Corporate Governance - Independent Directors, Non-Executive Chairs, and the Importance of the Devil's Advocate

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  • Randall Morck

Abstract

The Common Law, parliamentary democracy, and academia all institutionalize dissent to check undue obedience to authority; and corporate governance reformers advocate the same in boardrooms. Many corporate governance disasters could often be averted if directors asked hard questions, demanded clear answers, and blew whistles. Work by Milgram suggests humans have an innate predisposition to obey authority. This excessive subservience of agent to principal, here dubbed a "type II agency problem", explains directors' eerie submission. Rational explanations are reviewed, but behavioral explanations appear more complete. Experimental work shows this predisposition disrupted by dissenting peers, conflicting authorities, and distant authorities. Thus, independent directors, chairs, and committees excluding CEOs might induce greater rationality and more considered ethics in corporate governance. Empirical evidence of this is scant - perhaps reflecting problems identifying genuinely independent directors.

Suggested Citation

  • Randall Morck, 2004. "Behavioral Finance in Corporate Governance - Independent Directors, Non-Executive Chairs, and the Importance of the Devil's Advocate," NBER Working Papers 10644, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10644
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    References listed on IDEAS

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    1. Michael C. Jensen, 2010. "The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems," Journal of Applied Corporate Finance, Morgan Stanley, vol. 22(1), pages 43-58.
    2. Morck, Randall & Shleifer, Andrei & Vishny, Robert W, 1989. "Alternative Mechanisms for Corporate Control," American Economic Review, American Economic Association, vol. 79(4), pages 842-852, September.
    3. Renée B. Adams & Heitor Almeida & Daniel Ferreira, 2005. "Powerful CEOs and Their Impact on Corporate Performance," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1403-1432.
    4. Benjamin E. Hermalin & Michael S. Weisbach, 2003. "Boards of directors as an endogenously determined institution: a survey of the economic literature," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 7-26.
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    Cited by:

    1. Randall Morck & Lloyd Steier, 2005. "The Global History of Corporate Governance: An Introduction," NBER Chapters,in: A History of Corporate Governance around the World: Family Business Groups to Professional Managers, pages 1-64 National Bureau of Economic Research, Inc.
    2. Enrichetta Ravina & Paola Sapienza, 2010. "What Do Independent Directors Know? Evidence from Their Trading," NBER Chapters,in: Corporate Governance National Bureau of Economic Research, Inc.
    3. Dedu Vasile & Turcan Ciprian Sebastian & Turcan Radu, 2012. "An Introduction To Behavioral Corporate Finance," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(2), pages 471-476, December.
    4. Enrichetta Ravina & Paola Sapienza, 2006. "What Do Outside Directors Know? Evidence From Outsider Trading," 2006 Meeting Papers 882, Society for Economic Dynamics.
    5. Ahn, Seoungpil & Walker, Mark D., 2007. "Corporate governance and the spinoff decision," Journal of Corporate Finance, Elsevier, vol. 13(1), pages 76-93, March.
    6. Hélène Rainelli-Le Montagner, 2008. "Finance d'entreprise:voix nouvelles et nouvelles voies," Revue Finance Contrôle Stratégie, revues.org, vol. 11(Special), pages 291-313, June.
    7. Eric Santor, 2006. "Governance and the IMF: Does the Fund Follow Corporate Best Practice?," Staff Working Papers 06-32, Bank of Canada.

    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance

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