Board Dynamics: A Structural Investigation

Abstract

This paper studies how board structure changes with CEO characteristics. I estimate a structural model that endogenizes board structure, CEO firing, and firm performance. Adopting such an approach mitigates endogeneity concerns and allows for the exploration of some within-firm results that are difficult to document using regressions. I find a negative relation between board independence and CEO ability. This relation is strong when CEO ability is low, but it is weak on average. Further, when I restrict CEO ability to be the only CEO characteristic that can cause variation in board independence, the standard deviation of board independence in the simulated sample is less than 50% of its empirical counterpart. These results explain why the relation between board independence and CEO ability becomes insignificant in regression framework. Additionally, I find that appointing more outsiders only moderately improves the board's monitoring performance. The directors are unwilling to fire some low-ability CEOs because their private firing cost can be as large as $116 million on average. An outsider-dominated board reduces such a cost by less than 20%. Some low-ability CEOs are therefore able to keep their jobs even when the board comprises mostly of outsiders and board members hold a significant proportion of equity.