CEO and Chairman of the Board – The Corporate Governance Dilemma

How many times have we seen this designation in the corporate world? Does it ring any bell to you? Before we delve into this discussion, let us understand the background of why we need Board of Directors.

We, as a shareholder, delegate the decision making authority to the CEO and his team who by virtue of the position inside the company knows more than the shareholders do about the company’s operation. Of course, there are many information which the CEO and the managers may not share with the stockholders because it might help the competition. Hence there is an element of information asymmetry between the shareholders and the CEO and also a certain amount of performance ambiguity inherent in this relationship. In order to understand if the CEO is using the assets of the company effectively and efficiently, the shareholders monitors the performance through Board of Directors (BOD).

It is not a rocket science to conclude that the more independent a company’s BOD is, the better the quality of corporate governance. If the CEO chairs the Board, do you think that the BOD would be able to ask tough questions to the CEO? Studies of social psychology states that loyalty is hardwired into the human behavior. Although an important tool, but this loyalty can lead us to suppress internal ethical standards if it conflicts with the loyalty to the authority figure. If you are a part of BOD and you know that the CEO knows more about the company than you do, and if CEO is the chairman of the board itself, you might find it difficult to ask tough questions and challenge the CEO. Furthermore, the CEO as the chairman can choose his own BOD thereby putting the shareholder’s long term interest in jeopardy. This was pretty evident in the case of Disney in 1997 when Michael Eisner as the CEO and Chairman of the Board chose his own BODs and that board was rated the worst board by Business Week followed by the board of AT&T.

The next question is – Will it affect the value of the company in the long run? Of course, it will. If the BODs fail to challenge the CEOs, the CEOs can misuse the position in the following ways:

  • The assets of the company could be misappropriated in the form of excessive compensation or other perquisites. Example – Pfizer CEO, Hank McKinnel, earned an $83 M lump sum pension and $16 M in compensation in 2005, despite 40% decline in the stock price since he took over as CEO
  • The Management might enter into some transactions such as M&A that might not be in the best long term interests of the company
  • The managers might inflate the earnings and provide misleading financial reports. Recent example is Gowex (listed in MAB) fraud in Spain. The value of the equity dropped from 1.43 B euros to Zero after the exposure.
In sum, we cannot neglect the importance of the corporate governance today. If you are an investor and if you see the CEO also chairing the Board, you might spend time in due diligence before making a quick investment.