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Board Independence and CEO Turnover


  • I wish to thank an anonymous reviewer, Anil Arya, Tim Baldenius, Anne Beatty, Harry Evans, Ralf Ewert, John Fellingham, Esther Gal-Or, Jon Glover, Bjorn Jorgensen, Christian Laux, Helmut Laux, Christian Leuz, Pierre Liang, Nandu Nagarajan, Paul Newman, Douglas Schroeder, Richard Young, seminar participants at Carnegie Mellon University, City University of New York (Baruch), INSEAD, Ohio State University, Pittsburgh University, Tilburg University, UCLA, University of British Columbia, University of Texas at Austin, and conference participants at the Accounting Research Workshop at the University of Bern, the 2006 Association of German Business Professors Annual Meeting, and the 2005 American Accounting Association Annual Meeting for their helpful comments.


This paper analyzes how board independence affects the CEO's ability to extract rents from the firm. The CEO is assumed to possess private information about his ability, which the board needs in order to decide whether to replace him. If the board is more active in removing low quality CEOs, the incumbent is better able to use his information advantage to extract rents. Since the board cannot commit not to renegotiate the contract, a board that is fully independent from the CEO is more active than is efficient ex ante. For this reason, shareholders are better off if the board of directors lacks some independence. The model predicts that a trend toward greater board independence is associated with subsequent trends toward higher CEO turnover, more generous severance packages, and larger stock option grants.