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In the wake of scandals that ruined the likes of Enron and WorldCom, stacking independent corporate boards of directors with people from outside the company became the preferred means to govern CEOs. In theory, boards that exclude a CEO’s fellow executives would oversee the CEO better than a team that includes multiple company insiders, right? Not necessarily.
Research by two Harbert College of Business professors and their co-authors reveals that firms with “lone-insider boards” – boards whose only insider member is the CEO -- pay CEOs excessively, pay CEOs a disproportionately large amount relative to other company executives, have more instances of financial misconduct, and have less profits than firms with boards that include more than one company insider.
Michelle Zorn, Assistant Professor in Management, with her co-author Dave Ketchen, Lowder Eminent Scholar, published work “Home Alone: The Effects of Lone-Insider Boards on CEO Pay, Financial Misconduct, and Firm Performance,” which examined S&P 1500 companies from 2003 to 2014.
The study has been accepted for publication by the Strategic Management Journal and was recently featured in The Wall Street Journal.
The research team found that the pay of CEOs supervised by lone-insider boards is 82 percent higher than the pay of CEOs at firms that have multiple insiders on the board. They also found that companies with lone-insider boards are 27 percent more likely than other firms to commit financial misconduct. “These are big problems,” according to Ketchen, “because more than 60 percent of companies rely on lone insider boards.”
Why do these problems exist? “Sometimes there is too much separation, the directors are unable to adequately monitor the CEO, and the CEO is able to get away with a few extras,” said Zorn, who began this research seven years ago as a doctoral student at Florida State University. “We’re not saying that CEOs are always doing bad things. We’re saying that boards have to be careful about taking board independence to an extreme.
“A board’s primary roles are hiring a CEO, keeping an eye on that CEO, deciding what sort of pay the CEO should have, and when the CEO should be fired. Previously, it was expected that more independent boards lead to those decisions being better,” Zorn said. “People heralded board independence under the belief that the more independent a board, the better, because outside directors are more objective about the CEO’s performance and they should be able to better fulfill their roles.”
Zorn and Ketchen’s research suggests, however, that having other insiders on a board brings more information about the company to board discussions – information that is not filtered by the CEO – and the insights provided by that information led to better governance.
Zorn, who said studying boards, CEOs, and CEO compensation are within her research “wheelhouse,” relished the opportunity to work with a Harbert College colleague. “One of the most exciting things for me is the collaboration with Dave Ketchen,” she said. “He is one of the great scholars in our department and we are working together to create some great research. I’m a big believer in collaboration. By working together, we are achieving great things under the Harbert banner.”