Abstract
Shareholder delegation of the power to fire the CEO to the board of directors is central to corporate governance. While the board ideally acts as desired by shareholders, board entrenchment may insulate a poorly performing manager from shareholders agitating for her removal. The conventional 'costly firing' model of managerial entrenchment views this protection from shareholders as purely negative. Yet recent anecdotal evidence on managerial turnover suggests an alternative view of entrenchment: If shareholders misattribute poor performance to the CEO rather than to circumstance, then insulating management from the whims of shareholders may lead to better firing decisions. We propose that entrenchment has an inherent trade-off. We present a model that directly incorporates both sides of this trade-off, and generates a set of empirical predictions that we explore using recently collected data on governance statutes and on the dismissals of CEOs of large U.S. corporations. Our results demonstrate that governance is a very important mediating factor in the relationship between performance and firing. Furthermore, we find support for the 'misguided shareholder' view of entrenchment. Fundamentally this paper explores whether, in caving in to shareholder demands, boards act in the best interests of shareholders or simply respond to their whims: Do they do just do something, or do they do the right thing?
Highlights
From Adam Smith (1776) and Berle and Means (1932) to Hermalin and Weisbach (1998), economists have expressed concern about entrenched CEOs’ ability to pursue personal gain at the expense of shareholders
We analyze the role of entrenchment on performance surrounding CEO dismissal
We emphasize that entrenchment has potential costs and benefits, and the choice of entrenchment involves a trade-off. We illustrate this through a model that enumerates the trade-off between a traditional ‘costly firing’ view of entrenchment and an ‘ignoring misguided shareholders’ view based on the premise of performance misattribution
Summary
From Adam Smith (1776) and Berle and Means (1932) to Hermalin and Weisbach (1998), economists have expressed concern about entrenched CEOs’ ability to pursue personal gain at the expense of shareholders. The prevailing belief is that firms risk value destruction by self-serving CEOs, if they are left unchecked by weak boards or weak shareholders. Many companies have actively chosen to weaken shareholders’ powers with the explicit aim of ensuring that long-term profits are maximized. Facebook, LinkedIn, and Groupon completed initial public offerings (IPOs) with dual class share structures—with. In Google’s case, the company introduced a new class of nonvoting shares, saying, “outside pressures [from stockholders] too often tempt companies to sacrifice long term opportunities to meet quarterly market expectations.” Google’s concern about too much shareholders influence seems at odds with the traditional notion that entrenchment—the insulation of CEOs from shareholders—is bad for firms’ performance
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