Figureheads or potentates? CEO power and board oversight in the context of Sarbanes Oxley

• Author: Alessandro Minichilli,Alessandro Zattoni,Brian K. Boyd,Katalin Takacs Haynes
• DOI: http://doi.org/10.1111/corg.12293
• Published date: 01 November 2019
• Date: 01 November 2019

ORIGINAL ARTICLE

Figureheads or potentates? CEO power and board oversight in

the context of Sarbanes Oxley

Katalin Takacs Haynes

1

|Alessandro Zattoni

2

|Brian K. Boyd

3

|

Alessandro Minichilli

4

1

Department of Business Administration,

Lerner College of Business and Economics,

University of Delaware, Newark, Delaware

2

Department of Business and Management,

LUISS University, Rome, Italy

3

Department of Management, College of

Business, City University of Hong Kong,

Kowloon, Hong Kong

4

Department of Management and Technology,

University of Bocconi, Milan, Italy

Correspondence

Katalin Takacs Haynes, Department of

Business Administration, Lerner College of

Business and Economics, University of

Delaware, 210 Lerner Hall, Newark, DE,

19716.

Email: ktakacsh@udel.edu

Abstract

Research question/issue: We depart from studies that separately explore chief

executive officers' (CEOs') and boards' effects on firm performance. Instead, we

examine the direct relationship between CEO power and firm performance, and

how board monitoring, and most importantly, a change in the regulatory environment

alter the relationship. As such, our study jointly examines the role of both internal and

external corporate governance mechanisms on the relationship between CEO power

and firm performance.

Research findings/insights: Our findings indicate that the negative main effect of a

powerful CEO on firm performance is reduced by board monitoring and that the

Sarbanes Oxley (SOX) legislation amplifies board monitoring and reduces the negative

effects of CEO power.

Theoretical/academic implications: Our study shows that agency relationships are

grounded in social and institutional contexts. More precisely, our results suggest that

CEO power is a function of CEO's relationship with the board, as CEO power and

board monitoring interactions affect firm performance. Furthermore, they indicate

that the CEO‐board relationship is constructed within the legal institutional context,

as the shock of SOX alters the effects that different combinations of CEO power

and board monitoring have on firm performance.

Practitioner/policy implications: Our results highlight to investors and directors

that corporate boards should be designed in relation to the power of CEOs.

In addition, they provide valuable guidance for policy‐makers, suggesting that tight

regulations may represent effective deterrents for some CEOs' misbehaviors and

favor the alignment of interests with those of company owners.

https://capture.udel.edu/media/Katalin+Takacs+Haynes+-+Video+Abstract/1_

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KEYWORDS

Corporate Governance, CEO Power, Board Oversight, Sarbanes‐Oxley, Internal and External

Governance Mechanisms

Received: 5 July 2017 Revised: 12 April 2019 Accepted: 14 April 2019

DOI: 10.1111/corg.12293

402 © 2019 John Wiley & Sons Ltd Corp Govern Int Rev. 2019;27:402–426.wileyonlinelibrary.com/journal/corg

1|INTRODUCTION

Power, defined as “the capacity of individual actors to exert their will”

(Finkelstein, 1992: 506), when wielded by the chief executive, has the

potential to be a great asset, or a substantial liability. Powerful chief

executive officers (CEOs) can offer a consistent sense of direction

and faster decision speed but can also take strategic missteps due to

lack of oversight or abuse power in their own self‐interest. Consistent

with this ambivalent view about CEO power, studies into the direct

effect of top executives on firm performance are largely inconclusive

(e.g., Bergh et al., 2016; Certo, Lester, Dalton, & Dalton, 2006; Dalton,

Daily, Ellstrand, & Johnson, 1998). In this study, we argue that these

mixed findings might be indicative of more complex and nuanced

contingency relationships between executives, internal and external

corporate governance mechanisms, and firm performance (Boyd,

Haynes, & Zona, 2011; Kumar & Zattoni, 2019).

Corporate governance studies have mostly focused on whether

(and how) internal governance mechanisms prevent top managers'

behaviors aimed at pursuing their own interests at the expense of

shareholders and corporations (Aguilera, Desender, Bednar, & Lee,

2015). Among internal corporate governance mechanisms, scholars

have usually analyzed boards of directors as they are the apex of

the corporate control system. Board's primary role, according to

agency theory, is to monitor top managers to prevent managerial

opportunism and fulfill shareholders' interests (Fama & Jensen,

1983a, 1983b; Jensen & Meckling, 1976). Aggregate findings from

the broad and deep stream of agency‐based governance literature

suggest that board's effectiveness in performing its monitoring role

is variable and may be a function of the balance of power between

the CEO and the board (Boyd et al., 2011). Powerful CEOs can use

their power, or ability, to exert their will (Finkelstein, 1992) to act in

their own self‐interest, rather than serving the interests of the

owners. However, the board may be able to curb CEO's power if its

own power is bolstered by the appropriate structural characteristics,

such as a large number of directors with equity incentives (Boyd,

1995; Boyd et al., 2011) and relevant human and social capital

(Haynes & Hillman, 2010).

Although the corporate governance literature has usually focused

its attention on internal governance mechanisms, particularly boards

of directors, external governance mechanisms can also play a key role

in protecting shareholder rights (Aguilera et al., 2015). For example,

legal and regulatory institutions (e.g., investors' protection) may affect

ownership structures, private benefits of control, and governance

best practices (La Porta, Lopez‐de‐Silanes, Shleifer, & Vishny, 1998).

External corporate governance mechanisms can reduce top managers'

self‐serving behaviors both directly and indirectly by influencing

internal governance mechanisms. On one hand, the legal system

affects top managers' behaviors by providing both the norms they

must follow and the institutions to sanction improper behaviors. Con-

versely, the legal system affects top managers' behavior by influencing

internal governance mechanisms, for example, by establishing direc-

tors' fiduciary duties and the fines in case of their breach. In sum,

internal and external governance mechanisms affect top managers'

behavior and firm performance both directly and indirectly through

their interaction (e.g., Aguilera et al., 2015).

Following calls to examine internal and external governance

mechanisms holistically (Aguilera et al., 2015; Filatotchev & Boyd,

2009; Misangyi & Acharya, 2014; Walls, Berrone, & Phan, 2012),

we explore the effects of both internal and external corporate

governance mechanisms on the relationship between CEO power

and firm performance. As an internal mechanism, we analyze the

boards of directors as they have the fiduciary duties to monitor top

managers' behavior (Jensen & Meckling, 1976). As an external mech-

anism, we investigate the legal system as it regulates overall firm

governance and delineates the rights and duties of corporate actors

(Aguilera et al., 2015). In particular, we explore the effects of the

Sarbanes Oxley (SOX) Act in the U.S. context, as this radical reform

changed substantially duties and sanctions of both top managers

and directors.

Our theoretical framework is founded on agency and institutional

perspectives. First, building on literature in agency theory we examine

the direct effect of CEO power on firm performance, and the moder-

ating effect of three boards attributes that previous literature associ-

ated with board oversight, namely, board size, director shareholders,

and the presence of director‐CEOs from other firms. Then, following

calls to examine the joint effect of internal and external governance

mechanisms, we build on institutional theory to contextualize both

the CEO power‐firm performance relationship and the moderating

effect of board oversight in pre‐SOX and post‐SOX institutional

settings. By exploring the influence of the regulatory context on these

relationships, we bridge multiple levels of analysis to disentangle the

interactions between internal and external governance mechanisms

(Aguilera et al., 2015; Kumar & Zattoni, 2019).

We rely on a sample of S&P 500 firms for a 7‐year period centered

on the SOX implementation, using data on CEO power, board attri-

butes, and firm performance. We test hypotheses using a matching

contingency model (Venkatraman, 1989) that encompasses multiple

aspects of moderation. Our findings show that the CEO power–firm

performance relationship is highly nuanced: although CEO power gen-

erally has a negative effect on firm performance, this effect is reduced

by board oversight. Moreover, in line with our expectations, this mod-

erating effect is enhanced after the SOX Act, such that the legislation

appears to bolster the effect of a strong board, resulting in higher

performance.

Our study provides several contributions to corporate gover-

nance research. First, our findings extend traditional interpretations

of agency theory and support the idea that agency relationships

are grounded in social contexts. By highlighting that the negative

main effect of CEO power on firm performance is moderated by

board monitoring, the study extends the body of research that finds

that the effect of the CEO is contextual and interacts with other

phenomena to affect outcomes—such as strategic decision‐making,

or the governance of distressed firms (Dowell, Shackell, & Stuart,

2011; Haynes & Hillman, 2010). Second, our findings emphasize

the relevance of institutional contextual factors in the interplay

between CEO and boards of directors. As such they reinforce the

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