Can Shareholders Be Wrong?

Two views of board/CEO relationship persist. One is the common view that boards that are “entrenched” — or insulated from shareholder action — will ignore a struggling CEO to the detriment of shareholder interests. Such lax oversight is deemed to have played a role in allowing the recent spate of corporate scandals and record-setting bankruptcies to take place. The opposing view holds that boards that respond quickly to public sentiment could become agents of shareholders who are less informed. “[That view] is very much built on the model of a short-sighted shareholder agitator,” says Ray Fisman, associate professor at the Columbia University Business School and coauthor of the working paper Governance and CEO Turnover: Do Something or Do the Right Thing. However, Fisman says, caving in to vocal shareholders’ demands might not be in the best interest of all shareholders in the long run because shareholders may be too quick to misattribute a short-term stumble to a failure in the executive suite, when there may be extenuating circumstances or causes.

So which view captures what’s really happening in a typical boardroom? Fisman and his coauthors Matthew Rhodes-Kropf, an associate professor at Columbia Business School, and Rakesh Khurana, an associate professor at the Harvard Business School, examined 436 of the largest U.S. companies for which complete data could be assembled. They analyzed company data for the period from 1980 through 1996 and identified 728 CEO successions. On the basis of a literature search, they determined that CEOs were forced out in 180 of those successions.

For each company, the researchers measured the degree of board entrenchment by checking data on corporate bylaws from the Washington, D.C.–based Investor Responsibility Research Center. They looked for statutes that are generally considered to be unfriendly to shareholder rights, such as staggered boards or poison pills, which corporate governance advocates deem to be obstructive because they protect directors from shareholder action.

The data showed differences between companies with entrenched boards and others. For example, entrenched boards are less likely to fire a CEO, and when they do, their companies tend to experience greater improvement in operating income after the firing. However, although these findings suggest that entrenchment matters, they don’t shed light on whether cozy boards tend to be indolent or whether vocal shareholders tend to be shortsighted — because both views predict the same results.