CEO-director connectedness and firm’s operational risk

Abstract

ABSTRACT While internal controls are often carefully set by firm owners to manage risks, operational losses caused by errors in people and procedures could occur if board directors’ monitoring functions are weakened by having private connections with senior managers. This paper provides empirical evidence that the presence of social tie between a firm’s CEO and its board member is associated with a higher likelihood of operational risk events after other key determinants are controlled for. Our sample consists of 168 event and non-event firms that are publicly listed in the U.S. and spans over a historical period over 2000–2008 when the Basel II Accord is in full operation. Our results imply that existing provisions against operational risk should take CEO-director social ties as an additional factor that can undermine corporate governance and expose firms to a higher level of operational risk.