Monitoring CEOs: can insider-dominated boards do a good job?

Abstract

Purpose – The purpose of this paper is to examine the monitoring effectiveness of insider-dominated boards and outsider-dominated boards on different types of CEOs. Design/methodology/approach – To test whether boards monitor inside CEOs and outside CEOs differently and to compare the sizes of the effects across board types, the paper relates CEO resignations to performance measure. The paper tests the hypotheses using logit models to estimate the probability of a CEO change. Findings – It is widely believed that only an outsider-dominated board can provide effective management oversight. The paper finds evidence supporting this view after categorized CEOs based on their affiliation with their firms upon hire. However, the paper also documents that after the Sarbanes-Oxley Act of 2002 (SOX), an insider-dominated board is just as effective as an outsider board in monitoring if the CEO was initially hired from outside of the firm. This suggests that there is no difference between insider and outsider board monitoring of outside CEOs. Therefore, after SOX, as far as board monitoring is concerned, what matters is the independence between the CEO and the firm rather than the board structure itself. Research limitations/implications – If effective board monitoring is the reason of the revised listing standards approved by Securities and Exchange Commission (SEC) in 2003 to require companies listed on NYSE or Nasdaq to have a board that is composed of a majority of independent (or outsider) directors, the paper has provided more flexibility and choices to the listed firms. For example, firms that will be better off with insider boards can choose to hire outside CEOs because monitoring effects on outside CEOs are the same regardless of board types after SOX. Originality/value – The results of this paper have interesting implication. First, the paper has shown that an outsider-dominated board is still a better monitor even after categorized CEOs based on their affiliation with their firms upon hire. Second, if effective board monitoring is the reason of the revised listing standards approved by SEC in 2003 to require companies listed on NYSE or Nasdaq to have a board that is composed of a majority of independent (or outsider) directors, the paper has provided more flexibility and choices to the listed firms. For example, firms that will be better off with insider boards can choose to hire outside CEOs because monitoring effects on outside CEOs are the same regardless of board types after SOX.