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

Authors

  • Meg Adachi-Sato

    1. Royal Melbourne Institute of Technology University
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    • I am extremely grateful to Richard A. Braun, Hideshi Itoh and Kazuya Kamiya for their invaluable advice and constructive comments during the early stages of this research. I thank two anonymous referees, Ricardo Alonso, Bruce Chapman, Harrison Cheng, Leslie Hannah, Andrew Macrae, John Matsusaka, Chris Orme, Hiroshi Osano and Pierre Picard for helpful comments and suggestions on this paper. I also acknowledge the comments of students in the ECON 604 Game Theory course offered at the University of Southern California along with participants in seminars at the University of Southern California, Tokyo University, Hitotsubashi University and Australian National University. This paper was supported by the Global Center of Excellence (COE) Program, ‘The Research and Training Center for New Development in Mathematics’.

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.

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