Social Networks and Corporate Governance

Authors


  • I thank Nai-Fu Chen, John Doukas, David Hirshleifer, Pascal Maenhout, Massimo Massa, Joel Peress, Neal Stoughton, Siew Hong Teoh, Hong Zhang, and seminar participants at the INSEAD Business School, Fontainebleau, France, the University of California at Irvine, and the EFMA symposium on corporate governance at Bocconi University in Milan, for valuable comments.

Abstract

We analyse frameworks that link corporate governance and firm values to governing boards' social networks and innovations in technology. Because agents create social networks with individuals with whom they share commonalities along the dimensions of social status and income, among other attributes, CEOs may participate in board members' social networks, which interferes with the quality of governance. At the same time, social connections with members of a board can allow for better evaluation of the members' abilities. Thus, in choosing whether to have board members with social ties to management, one must trade off the benefit of members successfully identifying high ability CEOs against the cost of inadequate monitoring due to social connections. Further, technologies like the Internet and electronic mail that reduce the extent of face-to-face networking cause agents to seek satisfaction of their social needs at the workplace, which exacerbates the impact of social networks on governance. The predictions of our model are consistent with recent episodes that appear to signify inadequate monitoring of corporate disclosures as well as with high levels of executive compensation. Additionally, empirical tests support the model's key implication that there is better governance and lower executive compensation in firms where networks are less likely to form.

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