CEO influence on the board of directors: Evidence from corporate spinoffs

• Published date: 01 November 2020
• Author: Duong T. Pham
• Date: 01 November 2020
• DOI: http://doi.org/10.1111/eufm.12260

Eur Financ Manag. 2020;26:1324–1349.wileyonlinelibrary.com/journal/eufm1324

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© 2020 John Wiley & Sons Ltd.

DOI: 10.1111/eufm.12260

ORIGINAL ARTICLE

CEO influence on the board of directors:

Evidence from corporate spinoffs

Duong T. Pham

Department of Finance, Parker College of

Business, Georgia Southern University,

Statesboro, Georgia

Correspondence

Duong T. Pham, Department of Finance,

Parker College of Business, Georgia

Southern University, P.O. Box 8152,

Statesboro, GA 30460.

Email: dpham@georgiasouthern.edu

Abstract

We utilize a sample of spinoff firms that need to form

a new board of directors, to shed light on the chief

executive officer (CEO) influence hypothesis. We find

spinoff boards with a CEO who was the parent firm

CEO to be similarly structured to the boards of in-

dustry and size‐matched peers, whereas spinoff

boards with nonparent CEOs are structured for

greater monitoring. Consistent with our board

structure results, the CEO compensation and re-

placement decisions of parent CEO spinoff boards are

more lenient toward spinoff CEOs, whereas those of

nonparent CEO spinoff boards are more consistent

with protecting shareholder benefits.

KEYWORDS

board of directors, CEO compensation, CEO influence, CEO

turnover, spinoff

JEL CLASSIFICATION

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1|INTRODUCTION

The power of the chief executive officer (CEO) and CEO rent extraction behavior have become a

central problem of agency theory in which the board of directors is entrusted with diligently

EUROPEAN

FINANCIAL MANAGEMENT

I would like to thank Dr. John Doukas, the editor, three anonymous reviewers, and conference participants at the 2018

Southern Finance Association annual meeting for their helpful suggestions and comments. I would also like to thank

my dissertation committee chair and members, as well as faculty of the Department of Finance at the University of

Central Florida for their constructive feedback. All remaining errors are my own.

monitoring the firm's management. Evidence that the board of directors does not operate at

arm's length from the CEO's influence has been mounting. For example, Facebook independent

director Marc Andreessen and CEO Mark Zuckerberg were recently sued by investors alleging

that they cooperated to influence an independent board committee in the decision to grant

Facebook's CEO greater control of the company at the expense of its shareholders.

1

Even

though quantification of the CEO's influence and its harm to shareholder interest is challen-

ging, studies in finance have shown that the CEO has significant influence over the board of

directors.

2

In this study, we utilize a unique sample of tax‐free corporate spinoff firms to provide

further evidence of CEO influence on the formation and subsequent decisions of the board of

directors.

When a firm spins off part of its business into an independent publicly traded company, it

needs to form a new board of directors for the spun‐off business. These newly formed boards of

directors are often selected by the parent firm's board and management (Denis, Denis, &

Walker, 2014; King & Condit, 2001). Such a corporate divestitureevent creates a unique setup for

examining the CEO's influence on the formation of the board of directors and subsequent de-

cisions made by the spinoff board, since the influence of the spinoff CEO on the formation of the

board that monitors him/her can be better distinguishedbased on the source of spinoff CEOs.The

management of spinoff firms is often determined from three main sources. The new spinoff CEO

could be the former head of the spun‐off division, the parent firm's CEO, an executive within the

parent firm, or hired from outside the firm to run the newly independent business. Wruck and

Wruck (2002) document that more than 50% of spinoff CEOs in their sample from 1985 to 1995

were former divisional managers, about 20% were parent firm executives, and the rest were hired

from outside. Similarly, Denis, Denis, and Walker (2015) report that externally hired CEOs make

up only about 15% of spinoff CEOs in their spinoff sample between 1994 and 2010. Highly

influential parent management, particularly the parent CEO, is thus expected to have more

influence on the spinoff board's formation relative to similar influence from the parent firm's

executives and directors or CEOs hired from outside the firm.

Jensen and Meckling's (1976) agency theory regards corporate governance as a critical me-

chanism for safeguarding shareholders’benefits. Good corporate governance relies on a soundly

structured board of directors that is entrusted with monitoring, assessing, and advising the

management of the firm. However, under the agency framework, an agent would generally

dislike being monitored by the board of directors. Studies have shown that, given the opportunity

to influence the structure or composition of the board of directors, management would prefer less

monitoring (Coles et al., 2014; Hermalin & Weisbach, 1998; Shivdasani & Yermack, 1999).

Therefore, a highly influential parent firm CEO who becomes the CEO of a newly spun‐off firm is

expected to exert his or her influence consistently with decreasing board monitoring.

Examining tax‐free spinoffs from 1994 to 2014 from Thomson Reuters Securities Data

Company (SDC) Platinum, we find evidence that the boards of directors of spinoff firms

managed by former parent CEOs are only structured for monitoring similar to that of peer firms

of the same size and industry, whereas spinoff boards with nonparent CEOs (i.e. spinoff CEOs

who either used to be parent executives, parent directors, or divisional managers or were hired

from outside) are structured for greater monitoring relative to peer firms. Comparing the board

structures of spinoffs with those of industry‐and size‐matched peer firms, we find that the

1

See http://www.cnbc.com/2016/12/09/investor‐lawsuit‐accuses‐facebook‐director‐of‐disloyalty.html.

2

See, for example, Coles, Daniel, and Naveen (2014), Hallock (1997), Hermalin and Weisbach (1998), and Shivdasani

and Yermack (1999).

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