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 to mitigate endogeneity concerns. Adopting such an approach allows for the exploration of some within-firm results that are difficult to document using regressions. I find that CEO ability alone explains less than 50% of the variation in board structure, as measured by the standard deviation of board independence. Also, there is a negative relation between board independence and CEO ability. This relation is strong when CEO ability is low, but it is weak on average. These results explain why this relation becomes insignificant in regression models. 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 personal 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.