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Sunday, March 27, 2005

White Knights vs. Internal Candidates

From the New York Times:

Investors are often thrilled when well-known outsiders come in as white knights to run a company. But a growing body of evidence suggests that a company will perform better over the long run when it is led by a relatively anonymous insider.
Click here for the whole article.

The article discusses some the results found by Jim Collins, in his book "Good To Great." A surprising number of companies that have moved from matching to outperforming the S&P 500 did so with CEOs that came from within its own ranks.

It explains that the hiring of an outsider CEO is a common respose to poor stock market performance. However, this performance is sometimes due to problems outside the CEO's control.

The article goes on to cite a recent scholarly piece by Ray Fisman, Matthew Rhodes-Kropf, and Rakesh Khurana, titled "Governance and C.E.O. Turnover." It demonstrates how insulating the board from stockholder pressure to fire the CEO and replace him with an outsidercan be beneficial. Here's the abstract:

Shareholder delegation of the power to fire the CEO to the board of directors is central to corporate governance. While the board ideally acts as desired by shareholders, board entrenchment may insulate a poorly performing manager from shareholders agitating for her removal. The conventional 'costly firing' model of managerial entrenchment views this protection from shareholders as purely negative. Yet recent anecdotal evidence on managerial turnover suggests an alternative view of entrenchment: If shareholders misattribute poor performance to the CEO rather than to circumstance, then insulating management from the whims of shareholders may lead to better firing decisions. We propose that entrenchment has an inherent trade-off. We present a model that directly incorporates both sides of this trade-off, and generates a set of empirical predictions that we explore using recently collected data on governance statutes and on the dismissals of CEOs of large U.S. corporations. Our results demonstrate that governance is a very important mediating factor in the relationship between performance and firing. Furthermore, we find support for the 'misguided shareholder' view of entrenchment. Fundamentally this paper explores whether, in caving in to shareholder demands, boards act in the best interests of shareholders or simply respond to their whims: Do they do just do something, or do they do the right thing?
This provides some support for Steve Bainbridge's theory of "director primacy", which argues that decisionmaking power should be vested in the board of directors.

Update: welcome to all the folks stopping by from Professorbainbridge.com -- glad you're here.

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