Ceo Involvement in the Selection of New Board Members

THE JOURNAL OF FINANCE • VOL. LIV, NO. 5 • OCTOBER 1999

CEO Involvement in the Selection of New Board Members: An Empirical Analysis

ANIL SHIVDASANI and DAVID YERMACK* ABSTRACT

We study whether CEO involvement in the selection of new directors inf luences the nature of appointments to the board. When the CEO serves on the nominating committee or no nominating committee exists, firms appoint fewer independent outside directors and more gray outsiders with conf licts of interest. Stock price reactions to independent director appointments are significantly lower when the CEO is involved in director selection. Our evidence may illuminate a mechanism used by CEOs to reduce pressure from active monitoring, and we find a recent trend of companies removing CEOs from involvement in director selection.

A BOARD OF DIRECTORS SERVES AS THE PIVOTAL mechanism for monitoring the managers of a public corporation. Directors are voted into office by stockholders and have a fiduciary responsibility to protect stockholders’ interests. Along with their legal duties of reviewing the corporation’s major plans and actions, directors are charged with selecting, compensating, evaluating, and, when appropriate, dismissing top managers. A long-standing criticism of this process is that, in practice, directors are not selected by stockholders but rather by the very managers they are supposed to oversee. Mace ~1971! discusses anecdotal evidence of CEOs exercising authority in selecting candidates for the board, in effect hand-picking nominees. Similarly, Lorsch and MacIver ~1989! report survey evidence indicating that CEOs wield major inf luence in selecting new board members. Tejada ~1997! presents a recent news account of an outside director of a prominent company being denied nomination for reelection after criticizing management. Such allegations have led to proposals that boards choose directors through nominating committees composed only of independent members of the board ~see,...