A powerful chief executive officer (CEO) can be a great asset or a substantial liability for a company. The benefits include having a single person who is accountable for a company’s success or failure, who oversees a clear line of authority and who can initiate fast strategic responses to changing business conditions. This management principle is known as ‘unity of command’. However, there are risks associated with powerful CEOs. These individuals can exploit their power, behaving opportunistically or dishonestly.
They may be resistant to change within the business, or hold on to their position to the detriment of the company. They may simply have a poor work ethic. Previous studies on the effect of CEO power on company performance show mixed results, with a predominantly negative relationship. Our study argues that the relationship between CEO power and company performance can be better understood by analysing the moderating role of two contingency factors – the oversight of the company board and the effect of the Sarbanes–Oxley Act (SOX) of 2002.
Our research results indicate that the negative effect of powerful CEOs on firm performance is mitigated by the oversight of a board. In addition, they underline that the passing of SOX – a United States federal law that established new auditing and financial regulations for public companies – has reduced the negative effect of CEO power and amplified the positive effect of board oversight.
As such, our study highlights to investors and company directors that corporate boards should be designed to take into account the power of individual CEOs. In addition, our results suggest to policymakers that tight regulations can be an effective deterrent to bad behaviour by CEOs and be closely aligned with the interests of the company.
In the past, many scholars and practitioners have seen the optimal design of corporate boards as ‘box-ticking’. We argue that board design, in fact, plays a key role in the success of the company, and this may be more pronounced in the post-SOX period. Having an appropriately sized board and including directors who are also shareholders may support the board’s effective monitoring of powerful CEOs and the company’s overall performance.
Our research also examined the effect of having external director-CEOs on the board. While there are some potentially negative effects (e.g. closed friendship circles or cliques forming), positive effects include strengthening the board with highly competent and experienced individuals. It can also foster a sense of shared responsibility for the company’s success. These positive effects are stronger in the post-SOX period and are still highly relevant to businesses today.
Interestingly, our results also underline that corporate governance practices, and board oversight in particular, do not always have positive implications for company performance. This suggests that corporate boards should be designed in relation to the power of CEOs. In other words, when CEOs are powerful, high levels of board oversight can balance their power and its potentially negative consequences on company performance. However, when CEOs are less powerful, high levels of board oversight can undermine company performance. This is particularly true when there is an emphasis on controls, as in the post-SOX setting. Anecdotal evidence seems to support this conclusion. Many CEOs question what they see as the zero-trust and zero-tolerance environment after SOX, and underline the risks of a shift of power from company CEOs and executive directors to non-executive directors. In this way, our study also provides guidance for policymakers, suggesting that tight regulations can be an effective deterrent to bad behaviour by CEOs and be closely aligned with the interests of the company’s owners. In summary, our findings provide support for a contingency perspective on corporate governance, under which governance mechanisms should be designed, taking into account both the firm and institutional context.
Our research methods
We hand-collected data on both CEOs and boards of directors for S&P 500 US firms in the period 2000-2006 (three years before and four years after SOX). We measured company performance with return on assets (ROA). Following Finkelstein’s model of CEO power (1992), we measured CEO power through a composite index. We measured board oversight using three board attributes: size, the presence of director-shareholders, and the presence of director-CEOs from other companies. We introduced controls for company size, age, past performance, length of CEO tenure and the percentage of directors from outside the company. To test our hypotheses, we employed the fixed-effects model for panel data methodology.
Limitations of our study
Our study has some limitations. First, our analysis is biased towards large US firms. This limits the applicability of our results to other companies (e.g. those with concentrated ownership) and to other countries (e.g. where corporate law and regulations may be very different). In addition, we used well-established proxy variables (i.e. a proxy used in place of a variable that is hard to observe or measure) to explore complex constructs, such as the interaction among directors and CEOs. Furthermore, while our study shows the impact of SOX in the short-term, our results cannot be easily extended to capture its long-term effects.
Alessandro Zattoni is a Professor of Strategy and Dean of the Department of Business and Management at LUISS University in Rome. He has been a co‐EIC of Corporate Governance: An International Review (2013–2018) and is an editorial board member of Journal of Management Studies. He published more than 100 works on corporate governance, including articles in Strategic Management Journal, Journal of Management, Journal of Management Studies, Journal of World Business, Journal of Organizational Behavior, British Journal of Management, Journal of Business Ethics, Corporate Governance: An International Review, Industrial and Corporate Change, Journal of Business Research, and International Studies of Management and Organization.
Katalin Takacs‐Haynes is an Associate Professor of Business Administration and Bancroft Research Fellow at the Lerner College of University of Delaware. Her research interests include corporate governance, chief executive officer power, executive compensation, international and cross‐cultural management, corruption, and emerging topics on the dark side of management, such as greed and entitlement. Her research has been published in Administrative Science Quarterly, Journal of Management, Journal of Management Studies, Journal of Leadership and Organization Studies, and Strategic Management Journal, among others.
Brian Boyd is a Chair Professor of Strategic Management at City University of Hong Kong. His main research interests include corporate strategy, strategy implementation, international management, and boards of directors. He is an Associate Editor at Organizational Research Methods and has served previously as an Associate Editor at Corporate Governance: An International Review. He is also a co‐editor of six special issues at various journals. He has served multiple terms on the editorial boards of Strategic Management Journal, Academy of Management Journal, Academy of Management Discoveries, Journal of Management, Journal of Management Studies, Management and Organization Review, and Organizational Research Methods.
Alessandro Minichilli is an Associate Professor at the Department of Management and Technology at Bocconi University, as well as Director of Research and Director of the Corporate Governance Lab at SDA Bocconi School of Management. Alessandro authored more than 60 international scientific publications. His works have been published in Management Science, Strategic Management Journal, Journal of Management Studies, Family Business Review, and Corporate Governance: An International Review, among several others. He takes part in the editorial board of leading international journals such as Strategic Management Journal, Strategic Entrepreneurship Journal, and Journal of Management Studies.
Corporate Governance, CEO Power, Board Oversight, Sarbanes-Oxley, Governance Mechanism
Investors, directors, top managers