CEO Duality, Board Monitoring, and Acquisition Performance: A Test of Competing Theories

TLDR: In this article, the authors examine the relationship between CEO duality and acquisition performance and find that it affects performance negatively and there is an important interaction effect between outside board monitoring andCEO duality.

Abstract: Our paper presents an empirical examination of the relationship between CEO duality and acquisition performance. Specifically, we address two related questions involving CEO duality under the auspices of agency and stewardship theories. The first involves the extent to which CEO duality directly influences the profitability of acquisitions. The second involves the influence of duality and the nature of outside board monitoring on acquisition performance. Our study tests competing hypotheses drawn from these two perspectives. We find that CEO duality affects performance negatively and there is an important interaction effect between outside board monitoring and CEO duality. ********** Due to the increasing importance of corporate governance in organizations, there has been a growing body of research on the utility of CEO duality--particularly on the performance of firms that employ the dual structure. "CEO duality" refers to the situation where the same person serves simultaneously as CEO and chairperson of the board--a dual responsibility that has been subject to continuing debate. According to stewardship theory, such CEO duality establishes strong, unambiguous leadership, and shareholder interests are maximized by the shared incumbency (Chaganti, Mahajan, & Sharma, 1985; Donaldson & Davis, 1991; Finkelstein & D'Aveni, 1994). Agency theorists argue such a leadership structure represents a conflict of interest, in that a CEO who is responsible for the overall management also is in a position to evaluate the effectiveness of that strategy (Jensen & Meckling, 1976; Zajac & Westphal, 1994). Since these theoretical perspectives lead to opposing predictions on CEO duality, this study tests the direct and indirect performance effects of CEO duality, using arguments from both. A primary concern is whether CEO duality directly influences firm performance; i.e., whether there are differences in the financial performance of firms whose CEOs also serve as board chairpersons and firms that have separate individuals in those roles. Yet another issue is effective monitoring of CEOs by the board of directors when the CEO is chairperson of the board. Agency theorists suggest that boards of directors are a primary monitoring device protecting shareholder interests (Fama & Jensen, 1983). Although boards are sometimes vigilant and exert significant influence on the organizations they oversee (Dalton & Daily, 1998; Stiles, 2001), research shows that boards are not always effective stewards of organizational resources (Dalton, Daily, Ellstrand, & Johnson, 1998; Donaldson, 1995). According to agency theory, duality promotes CEO entrenchment by challenging a board's ability to effectively monitor and discipline (Allan & Widman, 2000; Dalton & Daily, 1998). Stewardship theory contends that additional monitoring by outside (individuals who are not current or former employees of an organization) directors is superfluous. The nature of board monitoring contingent on the presence or absence of CEO duality also may impact the profitability. Our paper examines the effects of CEO duality and outside director monitoring on profitability of acquisitions. While mergers and acquisitions are clearly on the rise, most deals do not create value. A study by Hayward and Hambrick (1997) examining why premiums above the market price often are paid to acquire another firm conclude that "CEO hubris" was an important factor in such overpayments. Related research does suggest that acquisitions are perhaps no better than break-even propositions for owners of acquiring firms (Morck, Shleifer, & Vishny, 1990). Moreover, target firm managers have become more skilled at extracting higher prices for their firms (Bradley, Desai, & Kim, 1988). If acquisitions are not ordinarily beneficial for the shareholders of acquiring companies, then why are they made? According to agency theory, many acquisitions are made because they benefit the senior executives. …