Does market power discipline CEO power? An agency perspective

DOIhttp://doi.org/10.1111/eufm.12240
AuthorRalf Zurbruegg,Anutchanat Jaroenjitrkam,Chia‐Feng (Jeffrey) Yu
Published date01 June 2020
Date01 June 2020
Eur Financial Management. 2020;26:724752.wileyonlinelibrary.com/journal/eufm724
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© 2019 John Wiley & Sons Ltd.
DOI: 10.1111/eufm.12240
ORIGINAL ARTICLE
Does market power discipline CEO power?
An agency perspective
Anutchanat Jaroenjitrkam
1,2
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ChiaFeng (Jeffrey) Yu
1
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Ralf Zurbruegg
1
1
Adelaide Business School, University of
Adelaide, Adelaide, Australia
2
Department of Finance, Thammasat
Business School, Thammasat University,
Bangkok, Thailand
Correspondence
ChiaFeng (Jeffrey) Yu, Adelaide
Business School, University of Adelaide,
10 Pulteney Street, Adelaide, SA 5000,
Australia.
Email: jeffrey.yu@adelaide.edu.au
Abstract
We examine how product market competition (PMC)
shapes chief executive officers (CEO) power. Using
various measures to capture both PMC and CEO power,
our analyses, which include a quasinatural experiment,
find evidence that CEOs have less power when the
product market is more competitive. Furthermore, the
impact of PMC on CEO power is more pronounced for
firms with entrenched management, lower CEO own-
ership, lower analyst coverage, and for firms experien-
cing good luck(windfall performance). Our results
suggest that market power can act as a substitute for
corporate governance in disciplining CEO power,
particularly when prone to agency problems.
KEYWORDS
CEO power, corporate governance, luck, market competition
JEL CLASSIFICATION
D22; G34; M52
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INTRODUCTION
Chief executive officers (CEOs) are the most dominant decisionmakers within firms. Firms
empower CEOs in order to reduce communication costs and improve operating efficiency so
that they can promptly respond to uncertainty (Nickell, 1996; Schmidt, 1997). CEOs, however,
EUROPEAN
FINANCIAL MANAGEMENT
We are very grateful to John Doukas (the Editor) and two anonymous reviewers for their constructive and insightful
suggestions and comments on this paper. We also thank Paul Brockman, Jean Canil, Ivan Obaydin, and Limin Xu for
helpful comments. All remaining errors are our own.
have a personal incentive to utilize their power for private benefits rather than shareholder
value (Bebchuk & Fried, 2004; Grinstein & Hribar, 2004). Moreover, powerful CEOs are
generally associated with weak corporate governance (Bebchuk, Cohen, & Ferrell, 2009;
Bebchuk, Cremers, & Peyer, 2011; Khanna, Kim, & Lu, 2015) such that it is difficult to mitigate
this agency issue with internal governance mechanisms. In this case, can product market
competition (PMC) play an external role in disciplining CEO power? Casual observations
indicate this possibility. Consider Facebook, seemingly a monopoly that dominates the social
media market. Its founder and CEO, Mr Zuckerberg, remains in his position even after the
Cambridge Analytica Scandal. In contrast, the cofounder and former CEO, Mr Kalanick, of
Uber, a leader in the competitive ridesharing service market, was forced to resign in June 2017
due to discrimination issues in the organization and following the #DeleteUber campaign.
These two examples suggest that CEOs of firms that face more direct competition, such as in the
case of Uber, may savor less power. In this study, we formalize this idea to establish our primary
hypothesis that PMC shapes CEO power.
CEO dominance, on the one hand, is subject to agency costs and thus reduces firm value
(Bebchuk et al., 2009, 2011; Chen, Huang, & Wei, 2013; Khanna et al., 2015; Liu & Jiraporn,
2010; Vo & Canil, 2019). Since PMC serves as an external disciplining mechanism and improves
the efficiency of firms (Chhaochharia, Grinstein, Grullon, & Michaely, 2017; Giroud & Mueller,
2010, 2011), stronger PMC should reduce CEO power. However, on the other hand, the ability
to respond fast to market conditions is considered a competitive advantage for firms and
granting CEOs more power can reduce the implementation time for corporate decisionmaking
(Cuñat & Guadalupe, 2005; Li, Lu, & Phillips, 2017). As such, powerful CEOs can benefit firms,
especially in the presence of heightened competition in the product market.
Furthermore, the effect of PMC on CEO power may crucially depend on the internal
governance of firms. Adams, Almeida, and Ferreira (2005) argue that powerful CEOs can
sometimes display very poor performance, and yet in other cases excellent performance,
depending on corporate governance and the firms corporate information environments.
Bebchuk et al. (2009) and Chhaochharia and Grinstein (2007) contend that in the absence of
corporate governance, agency problems are more likely to arise and adversely affect firm value.
Moreover, Giroud and Mueller (2010, 2011) and Chhaochharia et al. (2017) show that corporate
governance regulations have a greater impact on firms with less competitive product markets.
The above research leads us to posit that a significant moderating force in the relationship
between PMC and CEO power is when the firm is subject to greater agency problems. In
particular, given that CEO power can potentially inflate agency issues, one reaction to increased
PMC is for the firm to reduce CEO power when the firms internal corporate governance
structure is weak. The reason being that with increased competition, there is a greater
motivation for the firm to resolve agency issues in order to remain competitive in the new
environment. Conversely, if firms already have good corporate governance, then there is less
need to worry about the CEO using their power for private benefits. Indeed, in the presence of
good corporate governance there can be an advantage in providing CEOs with power as
additional CEO power will allow for firm management to respond more quickly to uncertainty
and profitability changes triggered by PMC (Cuñat & Guadalupe, 2005; Gaspar & Massa, 2006;
Li et al., 2017). Therefore, given the above arguments, we postulate additional hypotheses
around the notion that the impact of PMC on CEO power will be more pronounced where firms
are more likely to be exposed to agency problems, such as in the case where they have weak
internal corporate governance.
JAROENJITRKAM ET AL.EUROPEAN
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