Shareholder Empowerment and Board of Directors Effectiveness

Abstract

We develop a model to examine implications of empowering shareholders to replace the board of directors. We find that empowerment can benefit shareholders by providing incentive for boards to act in the best interests of the shareholders. Our results, however, also highlight unintended consequences. On one hand, boards might respond to the threat of replacement by taking action to extend their tenure at the expense of shareholders. On the other hand, empowerment might also lead to the replacement of boards that add value to firms. We find conditions under which empowerment either benefits or harms shareholders. In particular, we find conditions under which empowerment exacerbates the agency problems it is seemingly intended to address. We also discuss empirical implications of our main findings.