Interlocked Executives and Insider Board Members: An Empirical Analysis

This paper asked the question of whether the behavior and compensation of interlocked executives and non-independent board of directors are consistent with the hypothesis of governance problem or whether this problem is mitigated by implicit and market incentives. It then analyzes the role of independent board of directors. Empirically, we cannot reject the hypothesis that executives in companies with a large number of non-independent directors on the board receive the same expected compensation as other executives. In our model, every executive has an incentive to work. Placing more of non-independent directors on the board mitigates gross losses to the firm should any one of them shirk because they monitor each other. It also reduces the net benefits from shirking and increases the gross value of the firm from greater coordination (reflected in the firm?s equity value and thus impounded into its financial returns). Therefore having a greater non-independent director representation on the board create a more challenging signaling problem to solve thereby raising the risk premium. However, giving more votes on the board to non-independent executives fosters better executive working conditions, which in turn offsets the higher risk premium in pay by a lower certainty-equivalent wage in equilibrium. Thus, our estimates undergird a plausible explanation of how large shareholders determine the number of insiders on the board to maximize the expected value of their equity. We then conduct counterfactual policy experiment imposing 50% upper bound on the fraction of insiders on the board and another counterfactual imposing 40% quotas for women on the boards.