A review of Graham, J. R., H. Kim, and L. Mark, 2020, “CEO-Board Dynamics,” Journal of Financial Economics 137, 612-636.
I. Research question and its importance
Drawing on bargaining and dynamic contracting theories, this paper documents CEO-board dynamics. There are three reasons the topic is important. First, most prior research failed to collect enough data to make within-firm and within-CEO analyses, leaving the question unanswered empirically. Second, albeit a well-documented negative relationship between executive tenure and board monitoring intensity, the temporal trend was not focused in early work. In other words, lacking panel data, it’s unclear how board monitoring intensity changes along CEO tenure. Third, the 2002 regulation change provides a good exogenous shock which researcher can exploit to evaluate the impact of substitution to CEO duality. Because the new regulation requires higher level of board independence (i.e., higher ratio of independent directors, following HW’s measurement), CEO duality hence provides an alternative facing the change. These three reasons make the topic worth investigating.
II. Method, finding, and limitation
The authors collect a new panel dataset from 1920 to 2011 which allows them to conduct within-firm and within-CEO investigations. Instrument variable and time series techniques were employed to analyse the data. Their key findings can be categorized into two parts. For one, board independence increases as CEO tenure decreases, and is significantly higher in the event of CEO turnover. This is aligned with the proposition that board increases its monitor intensity when CEO ability is under scrutinization. In the same manner, they show board independence declines after strong CEO performance. While on the other hand, as CEO tenure increases, the probability of duality increases, too. This corresponds to the notion that duality circumvents the new regulation on corporate governance. Yet, the model fell short in incorporating several issues. Amongst them, the effect of CEO tenure is small given the strong persistence (i.e., independence ratio remains very stable) documented by the paper, implying omitted variable exists. Also, the authors found board independence decreases during external CEO hiring, by which they postulated the advisory role of directors. Finally, exploiting the sudden death of powerful CEO (i.e., long tenure with sound performance) they found that company enjoys higher stock price, indicating CEO entrenchment.
III. Future research
Answers to this old research question (i.e., agency problem) diverse despite using new data. Many alternative explanations weren’t ruled out by the paper. For instance, board seat may be a means of reward for supporting CEO’s performance, instead of monitoring or advisory role. Meanwhile, the current model does not consider factors that influence both CEO hiring decision and board independence at the same time, e.g., macroeconomic factors. Finally, the stock price increase following the sudden death of a powerful CEO might be caused of ownership contest, which was left unattended by this paper. In brief, the paper points out many opportunities for future works.