Insular Decision Making in the Board Room: Why Boards Retain and Hire Substandard CEOs

Abstract

This paper explores why a corporate board often fails to replace a substandard CEO. I consider the situation in which the incumbent CEO and directors make decisions in the absence of the new CEO. I show that the board and the CEO maximize the expected utilities of the negotiating parties that do not include the expected utility of the potential CEO. This sometimes results in the retention of an inefficient CEO. I argue this same logic provides a theoretical explanation for how a new CEO is chosen in relation to both the voluntary and enforced replacement of an existing CEO.

Stock vesting conditions, control benefits and managerial replacement

“…Adachi-Sato (2015) examines a misalignment of the interest between the board and the firm using a Nash bargaining model without moral hazard problems.…”