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Insular decision-making in the board room: why boards retain and hire sub-standard ceos

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  • Meg Sato

Abstract

It is widely believed that corporate boards are overly reluctant to fire their CEOs. The conventional explanation for retaining a CEO regardless of his/her talent is that a CEO chooses the board members and has the power to fire them. However, very few studies have investigated how a new CEO is chosen. This paper explores an unexamined cause of board reluctance in removing a CEO: the incentive to minimize the leakage from the decision-makers’ future surplus. I argue that this same logic provides the theoretical explanation for how a new CEO is chosen for both voluntary and forced CEO replacements. I show that this incentive of the incumbent board and CEO often departs from the shareholders’ interest. In short, if the net surplus of the incumbent board and CEO is expected to be larger under an incumbent sub-standard CEO, or under an internal candidate rather than an external candidate, then they retain the incumbent sub-standard CEO or promote an internal CEO candidate, even though the expected corporate profit generated by appointing an external candidate is likely to have been greater.

Suggested Citation

  • Meg Sato, 2009. "Insular decision-making in the board room: why boards retain and hire sub-standard ceos," Asia Pacific Economic Papers 384, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.
    • Handle: RePEc:csg:ajrcau:384
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    File URL: https://crawford.anu.edu.au/pdf/pep/apep-384.pdf
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    Cited by:

    1. Meg Sato, 2010. "Board's Monitoring and Retention of Sub-standard and Powerless CEOs," CIRJE F-Series CIRJE-F-711, CIRJE, Faculty of Economics, University of Tokyo.

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    More about this item

    JEL classification:

    • D79 - Microeconomics - - Analysis of Collective Decision-Making - - - Other
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • L29 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Other
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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