Corporate board dynamics.

Abstract

This dissertation is composed of two chapters which examine the dynamic aspects of the corporate board of directors. In the first essay, I propose a dynamic model in which corporate directors perform firm tasks (such as monitoring management) and choose new directors. Previous literature has focused on the board composition that statically optimizes firm tasks. I incorporate features of these models and give directors the additional task of hiring new directors. This introduces an important dynamic element: the board must consider both how new directors will perform in firm tasks and how new directors will try to change board composition in future hiring rounds. I find that the optimal board composition in the dynamic model differs from that of the static model. Additionally, lack of a commitment mechanism means directors do not always choose board compositions that maximize shareholder value. This creates an opportunity for policy to benefit shareholders. In 2003, the NYSE and Nasdaq exchanges implemented two new rules. First, boards must be composed of a majority of outside directors. Second, director selection must be done by a nominating committee composed of outside directors. I use the model to analytically and numerically investigate the effects of these new regulations on shareholder value. I find that the regulations may benefit shareholders of a firm in the dynamic environment, but never benefit shareholders in the static environment. In the second essay, I examine the response of corporate boards to the majority independent outsider policy of the NYSE and Nasdaq stock exchanges. I estimate a two period model of the board composition choice before and after the regulatory change. In this model, boards stray from the expected optimal independence and board size in response to the quality of individual director candidates. I use the model to investigate the counterfactual experiment of no majority outsider regulation. The model predicts that nearly 59% of firms not in compliance with the majority outsider rule would have moved into compliance even in the absence of the majority regulation. Factors other than the static response to majority outsider rules account for 60% of the observed increase in board independence among non-compliant firms over the years of regulation. These factors may be contemporaneous changes in committee requirements, general trends in corporate governance, or the dynamic considerations examined in the first essay.