Post on 23-Mar-2018
Bachelor thesis
CEO duality at S&P 500 and FTSE 100 companies
December 1st 2004
Sjoerd Arlman, 9900578
Accompanying professor: dr. C.M. van Praag
Faculteit der Economische Wetenschappen en Econometrie
Universiteit van Amsterdam
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1. Introduction
Since the Cadbury commission published its report on corporate governance in 1992,
governance has been a widely published and hotly debated topic. The interaction between a
company and its share- and stakeholders, the way the board is run, the number of
independent directors and the salary of the CEO are all issues related to corporate
governance that have received quite some attention. In most countries the discussions
regarding corporate governance were given an extra push by the emergence of corporate
scandals at (formerly) well-respected firms like Enron, Tyco, Ahold and Parmalat.
A difficulty in corporate governance is that almost every country in the world has its own
way of doing and regulating business and therefore its own corporate governance system,
leading to considerable differences in corporate governance between countries.
One of the factors in corporate governance that is different all around the world concerns
the issue of CEO duality, which is the situation when the same person holds both the job of
Chief Executive Officer (CEO) and Chairman of the board of a firm. In some countries
especially countries that have a two-tier board CEO duality is non-existing. In other
countries it is almost taken for granted. For example, in 1987 Dalton and Kesner found that
for a small sample of US and UK firms, some 30% of the UK companies had the same
person as chairman and chief executive while the figure was 82% for the USA.1
For my own research I have compared the duality in US firms in the S&P 500 index with
UK firms in the FTSE 100 index. This research shows that only 4% of FTSE 100 companies
have the same chairman as CEO, while the figure for the S&P 500 companies is 76%.
Apparently in the 17 years since the research by Dalton and Kesner, more UK firms have
decided to split the top two management positions. In the USA the number of firms with
two different individuals as Chairman and CEO has also increased, but is still much lower
than in the UK. Therefore while both the UK and the USA are classified as having similar
1 Dalton, D.R., Kesner, I.F., p 39.
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Anglo Saxon corporate governance and business structures, they are at least concerning
this duality issue quite different.
In this paper I will present the results of my research regarding CEO duality in the UK and
the USA in more detail. As the USA has a much lower degree of separation, I will look in to
the possible explanations for this trans-Atlantic difference.
Also I will look into two related topics.
The first concerns CEO remuneration. Entrenchment theory claims that entrenched CEO s
often earn more money than their peers, as they are able to influence or dictate board
remuneration decisions. It is often claimed that CEO duality has an increased chance of
leading to CEO entrenchment.2 I will research if CEO s who also occupy the chairman s seat
have a higher remuneration than their peers who are just CEO.
The second issue regards CEO tenure. According to a common succession theory an
outgoing CEO/Chairman will often stay on as chairman a number of years after having
retired as CEO. Furthermore, if after a period of time the incoming CEO has proven
himself capable, the former CEO who still holds the chairmanship will step down as
chairman, enabling the incumbent CEO to also become chairman.3 I will test this succession
theory by comparing the tenure of CEO s who also hold the chairmanship with CEO s who
have a predecessor running the board. My hypothesis is that the latter group has shorter
tenures than the former.
In the next section I will go into the theoretical issues of corporate governance, board
structure and CEO duality in more detail. The third section contains information about my
research and my research results. In the fourth section I will analyze the results of my
research and give possible explanations for the results. Also I will give an outlook into the
future regarding CEO duality. The fifth and final section contains a summary and conclusion
of my findings.
2 Among others by Morck, Schleifer and Vishny (1988) and Finkelstein and D Aveni (1994). 3 See for example Harrison, Torres and Kukalis (1988) and Vancil (1987).
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2. Corporate governance and board structure
According to the definition given by the OECD, corporate governance is the set of
relationships between company management, board, shareholders and other stakeholders.
Important other elements are the structuring of objectives, the means of attaining those
objectives and the manner in which the company is monitored.4 Other definitions describe
corporate governance in terms of protection of (mainly minority) shareholders or prevention
of fraud and corporate scandals.
As business practices and differ between the various countries and regions, there are also
large differences in corporate governance practices. Customs that are completely normal in
one country may be unheard of in another. For example, the Netherlands uses a much
frowned upon cooptation system for the election of supervisory board members, which in
essence means that current board members select their peers.
Starting in the UK with the Cadbury Commission in 1992, there have been numerous
attempts in most developed (and some developing) countries to codify these governance
issues and set a (national) standard.5 Paradoxically while the USA is claimed by many to have
the most advanced corporate governance systems in the world, it is one of the few
developed countries which does not have a national code of corporate governance. Instead
the USA has restricted itself to occasional changes in listing requirements of the exchanges
and various discussion papers by different groups, ranging from investment funds like
CalPERS or IIS to business associations such as the Conference Board or the Business
Roundtable. Only in the past few years has the US resorted to stricter measures, including
legislation on a federal level such as the quite recent Sarbanes-Oxley act.
As mentioned there are large differences in business practices and corporate governance
around the world. One major international difference is in the structure of the board of
directors. Some countries have a so-called two-tier board system, with one executive board
that is responsible for the day-to-day management and one supervisory board that monitors
the executive board. Other countries have a one-tier system with just one board containing
4 OECD, p 2. 5 For a list of corporate governance codes in different countries, see http://ecgi.org/codes/
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executives as well as non-executives. Most European companies operate a two-tier system,
while most Anglo-Saxon companies use the one-tier system. There are however exceptions,
for example the French mostly have one-tier boards.
In regard to that issue of board structure there is one quite sensitive difference, namely the
separation or not of the functions of chief executive and chairman. In two-tier board
systems, the separation between the two top jobs is almost implied. In the one-tier system
the results are more mixed, with some countries and companies opting for a unitary
leadership structure with the same person as CEO and chairman, and other companies
opting for a dual leadership structure which separates the two top jobs.
Before discussing the trade-offs between a unitary leadership structure (with one person as
CEO and chairman) as opposed to a dual leadership structure (with a separation between the
two most senior jobs), it is relevant to first go into the different roles of the board, the
chairman and the CEO.6 Although even these roles are the subject of academic debate, there
are a number of points that stand out.
Roles of the board, chairman and CEO
The most important roles of the board are to monitor management, review the strategy, and
pick executive directors. In doing this the board must be careful not to take over the
executive tasks from the CEO and his colleagues. However the board must also be careful
that it does not rubber-stamp everything the chief executive says and does. There is still
quite some discussion whether the board is the representative of the shareholders7 or the
firm in general.8
The chairman is responsible for the functioning of the board. This means that he runs the
board, sets the agenda and ensures that the other board members obtain information timely,
6 A fourth important group could be added to this list: shareholders. However, I will not go into the roles of shareholders in this paper. 7 Advocated by among others the Conference Board and in the papers of Condit and Hess (2003) and Vance (1983, in Finckelstein and d Aveni (1994)). 8 Advocated by among others the Combined Code on Corporate Governance in the UK (2003) and by some CEO s in the review by Spencer Stuart (2003).
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clearly and accurately. The chairman should stimulate the other board members to take part
actively in discussion and assure that his peers are sufficiently skilled to perform their duties
as board member. While not the main person to communicate with shareholders, the
chairman should ensure that the views of shareholders are known to the board.9
As the name clearly indicated the CEO is the first and foremost executive responsible for
the day-to-day operations of the company. The chief executive is the main representative of
the company to all share- and stakeholders.
Duality or separation
The debate around the separation or integration of the jobs of CEO and Chairman is a
frequently debated topic in corporate governance. It is not difficult to see the potential
conflict of interest when the two functions are combined. As the chief executive is
monitored by the board of directors it is therefore in the CEO s interest to present
information to the board that makes his results look good. Therefore, having a CEO who is
also chairman of the board gives a situation where the CEO is basically marking his own
exam papers. 10 Mallette and Fowler (1992) argue that in combined roles the chairman of the
board must make decisions as chairman that influence his personal well-being as CEO,
potentially leading to a conflict of interest. The authors argue that as chairman the CEO can
set (and therefore influence) the board s agenda and the CEO can influence (if not control)
the nomination of directors for the board. Their research into the adoption of poison pills11
by companies shows that firms with dual leadership adopt less poison pills. Mallette and
Fowler therefore conclude in their paper that CEO duality can challenge a board s ability to
monitor executives.12
A CEO who can influence or even decide on the appointment of board members changes
the incentives for (independent) directors. Because of the power of the CEO, a reputation
for asking difficult (but necessary questions) may not be in a director s best interest, while a
9 Combined code, p 5. 10 Dedman (2002), p 345. 11 This is a strategy to avoid a hostile takeover bid, often by taking on large debts or otherwise diluting the value of the company s stock. 12 Mallette and Fowler (2002), p 1028.
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reputation as yes man will most probably serve the director well.13 Kenneth Lay, former
CEO of Enron is supposed to have said that filling the board of directors was up to what
the CEO saw fit for the company at that moment.14 Jensen and Fuller (2002) argue that the
management rights must be separated from the control rights at all levels of the
organization, especially at the board level.15
Related research by Shivdasani and Yermack (1999) points out that when the CEO is
involved in the nomination process of directors firms are less likely to appoint aggressive
monitors or independent outsiders and are more likely to appoint gray directors with a
conflict of interest.16 Going even further, Mace (1986) has shown that in many cases
directors remain loyal to misguided CEO s.17
In a recent survey done by Spencer Stuart (2003) all of the CEO s interviewed indicated that
a good relationship between the chief executive and chairman was essential for the well
functioning of the board. Therefore simply appointing an outside (and unknown) director as
chairman is not as straightforward a solution as it seems. Besides the fact that CEO and
outside Chairman have to get along, an outsider will
ceteris paribus have less knowledge
about the firm and the business the firm is in. Besides, having a separate person as CEO and
chairman adds an extra layer in the firm s organization.
Therefore, the main tradeoff in the discussion of splitting roles of CEO and Chairman is
basically between efficiency because of unitary leadership or accountability with a dual
leadership structure.18 On the one hand, proponents of the agency cost theory argue that the
combination of the two functions leads to high chance of entrenchment of the chief
executive and dilutes the monitoring role of the board. They argue that the combination of
decision management and decision control is a fundamental flaw. Again, by also being
chairman of the board, a CEO is in essence monitoring his own performance.
13 Morck (2004), p 20. 14 However, according to Sonnenfeld (2004), the director attendance at Enron meeting is supposed to have been nearly perfect. 15 Jensen and Fuller (2002), p 9. 16 Shivdasani and Yermack (1999), p 1852. 17 Mace (1986) in Morck (2004), p 10. 18 Koningsberg (2004), p 35.
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Furthermore Collier and Gregory (1999) provide evidence that a CEO who also fills the
function of chairman is negatively associated with the activity of the audit committee, one
possible proof for the dilution of board monitoring in the case of duality. As the recent
corporate governance scandals at companies such as Ahold, Parmalat and Enron have
shown, the auditing of a company is quite important.
The other side of the argument prefers unity of command at the top of the firm and a single
person who is accountable for firm outcomes vis-à-vis the different stakeholders.19
Proponents for these arguments assert that there are a number of costs associated with the
separation of the functions of the CEO and chairman. First of all there is the issue that is it
much more difficult for a non-CEO chairman to know the business sufficiently well.
According to Campbell (1995) this problem can even be made worse when the influence of
independent directors is increased due to the influence of the non-CEO chairman, thereby
increasing the voice of the non-experts . An easy solution for this issue is used by many
firms, namely to have the (former) CEO in the chairman s seat.
The second group of costs are agency costs. While an independent chairman reduces the
agency costs related to monitoring the CEO s behavior, it introduces the additional costs of
checking the chairman s conduct. Included in these costs are the abovementioned costs of
introducing another layer of organization in the firm.20
A third reason for firms not to split the two top jobs is the loss of clear responsibilities. In a
unitary leadership structure it is quite clear which person is responsible for all firm outcomes.
However as mentioned above, in a dual leadership structure there are costs associated with
the fact that there is not one person solely accountable for performance.21
As mentioned above, a major reason for firms to place a former CEO in the chairman s seat
is for orderly transition of the company management. Many firms maintain a succession
method wherein the outgoing CEO remains chairman until the new CEO is accustomed to
the job and can also take over the chairman s seat. In this theory, the prospect of becoming
19 Coles and Hesterley (2000), p 198. 20 Campbell (1995), p 107. 21 Brickley, Coles and Jarrell (1997), p 195.
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chairman is another incentive for the CEO to do well. According to proponents, this
succession formula also leads to better use of the outgoing CEO s information.22
22 Arguments in this direction have been made in the articles by Coles and Hesterley (2000), Finkelstein and d Aveni (1994) and Brickley, Coles and Jarrell (1997).
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3. Research into CEO duality in S&P 500 and FTSE 100
companies
In this section I will show the results of my empirical research into the practice of CEO
duality in S&P 500 and FTSE 100 firms. For both groups of firms the data was collected in
August of 2004.23 The composition and data for the S&P firms was accessed from The
Corporate Library (including Board Analyst) and individual company websites. Information
for the FTSE firms was acquired from FTSE, Hemscott and also from individual company
websites.
For the FTSE 100 firms the dataset only included the name of the firm and the names of the
CEO and chairman. The dataset for the S&P 500 firms included not only the names but also
among others the tenure of the current CEO, his or her annual salary, the number of shares
held and the position of the chairman.24
The data were checked for consistency, which resulted in the discarding of a number of
results from the list of S&P 500 companies, leaving 486 in the data set.25 No inconsistencies
were found in the FTSE 100 list. Only one firm is in both the S&P 500 as well as the FTSE
100, namely Carnival.
In my sample of 486 S&P 500 companies, I found that 24% (119 companies) had a different
chairman than CEO. For the FTSE 100 companies 96% had a split between the function of
CEO and chairman. In comparison with the results of Dalton and Kestner (1987), it seems
that the amount of firms with a separate chairman from CEO has grown in the past years.
However, while today the UK has almost complete separation between the office of
chairman and CEO, the Americans still prefer to combine the two jobs in more than three
out of four companies.
23 The author would have preferred comparing the duality data for 2004 with data for earlier years. However the data prior to 2003 was only attainable at great financial cost, which regrettably was outside the scope of this paper and the author s financial situation at this time. 24 Current CEO, former CEO, other executive director, outside director etc. 25 The main reasons to exclude certain entries were unavailability of information and changes due to takeovers or mergers.
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CEO duality and CEO tenure
Of the 119 companies of the S&P 500 that had a different person occupying the position of
CEO and chairman, 69 firms had a former CEO as chairman. If we consider the succession
theory, meaning that former CEOs stay on as chairman until the incumbent is proficient
enough, we would suspect that the current tenure for CEO s in these companies to be
relatively short. The data supports this hypothesis. In my dataset of 486 firms, the average of
the CEO s tenure in all firms is 6.3 years. However, the average tenure for CEO s who are
not chairman is 3.4 years and even less at 2.7 years for companies with a former CEO as
chairman. In companies with the current CEO doubling as chairman, the average tenure is
7.2 years. These last results could also point out that a combined CEO/Chairman has
enough power to remain in the job for quite some time, giving some strength to the
entrenchment objections of the opponents of unitary leadership structure. Also the results
could point out that the succession theory is valid, as the CEO tenure of companies with a
former CEO in the chairman s seat is significantly lower than other companies. At a 95%
confidence level all differences in tenure are statistically significant.26
One of the factors that I did not take into account in my research was the fact that in a
number of firms with a former CEO as chairman that particular person is one of the
founding fathers of the company. Being founding father this person will more often than
not remain chairman, not stepping down for the incumbent CEO even if the latter performs
well. Examples of these kinds firms are Intel, Microsoft, Analog Devices and E-Bay. The
data shows that the tenure for the current CEO in these firms is decidedly higher than in
other firms with a former CEO as chairman. Discarding these firms from the dataset would
probably lead to an even shorter tenure for CEO s with a predecessor in the chairman s seat
and therefore give even more strength to the succession theory. The same argument could
also be made for firms with a (grand)child of the founder as chairman, such as Ford or (until
a few years ago) Philips.
CEO duality and CEO remuneration
26 For the statistical results, please refer to appendix 2.
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Another factor I looked at was total CEO compensation for S&P 500 executives in 2003.
The average total annual compensation for CEO s in the S&P 500 was $ 2.71 million. The
average for firms with a single person as CEO and chairman is a bit higher, at $ 2.80 million
annually. This figure is lower in firms where a former chief executive is chairman ($ 2.63
million) and is even lower in firms where the chairman is neither current nor former chief
executive ($ 2.15 million). CEO s who also hold the chairmanship earn on average 30%
more than their peers who are not in the chairman s seat themselves or have a predecessor in
that position. At a 95% confidence level, only this last difference is significant. However,
considering the fact that a combined CEO/chairman is in fact doing both jobs, and the
American tendency to overcompensate executives, I do not find the difference in
compensation stunningly large.27
27 For the statistical results, please refer to appendix 2.
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4. Interpretation of results and discussion
As mentioned before, in 1988 only 70% of UK companies had a split between the jobs of
CEO and chairman compared to the 96% of today.28 The movement to almost complete
separation between chief executive and chairman gained an impulse with the Cadbury
commission on corporate governance in 1992. The commission recognized that the
combination of the two functions was a considerable concentration of power. It therefore
suggested that the role of the chairman should in principle be separate from that of the chief
executive.29 A decade later the combined corporate governance code plainly stated that the
roles of chairman and chief executive should not be exercised by the same individual. 30 Note
however that the UK has a so called principles system , which means that the provisions of
the code are not binding in its entirety. A firm may deviate from the code, as long as it
explains its reasons to do so.31
The United States operates a different corporate governance system. The US system is not
principles based like in the UK but rather more rules based , built on the strict application of
rules and regulations. Although the unitary leadership structure is not obligatory in the USA
it is frequently used, probably due to sociological reasons. Historically, independent
chairmen have only been acceptable in the US during transitional periods or when the CEO
is weak or new to the job. A combination of the two jobs is seen as powerful in the US,
probably also reflecting the American idea of the CEO as Superman.32 There is a saying in
the US that every American wants to become president. If the presidency of the USA is not
achievable, a company presidency (combined with the chairmanship and job as CEO) is the
next best thing.
28 Unfortunately the dataset for the 1998 data is a different one than the one used in this paper, hampering a completely sound comparison between the two figures. However the degree of firms with a dual leadership structure has probably increased in the past decades. 29 Cadbury et al (1992), p 20. 30 Financial Reporting Council (2003), p 6. 31 This system, which is gaining in popularity both inside as well as outside of the UK, is commonly known as a comply or explain
or even an apply or explain or blame and shame system. 32 Koningsberg (2004), p 35.
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As shown in my research above, the succession theory is one of the reasons given to split the
jobs, even if only temporary.
Another situation in which firms choose to split the two top jobs is in the case of a merger
or major acquisition. Often the two CEOs will agree that one becomes CEO of the merged
company, while the other takes the chairmanship of the board. For example, in the recent
Bank of America and Fleet Boston merger, the Bank of America CEO and chairman
Kenneth Lewis became CEO of the merged firm, while Charles Gifford CEO and chairman
of Fleet Boston became chairman.
One of the main drawbacks put forward by the opponents of CEO duality is (the risk of)
CEO entrenchment. As my research shows, CEO s that also hold the job of chairman have
been in office for more than seven years, ceteris paribus increasing the chance of
entrenchment. Research in this field, most notably by Morck, Shleifer and Vishny (1988)
shows that firms with CEO duality are less likely to fire the CEO after bad performance,
strengthening the fear for entrenchment. Also Brickley and James (1987) have shown that
firms that combine the function of chairman and CEO tend to be larger with older CEO s,
longer tenures and larger CEO share ownership. The risk of entrenchment is quite high in
these cases.
My research has shown that CEO s who also hold the job of chairman have a relatively long
tenure in comparison with their peers. Note that I recognized three categories, namely firms
where CEO and chairman are the same person, firms with a former CEO as chairman and
firms with someone other than the current or former CEO as chairman. The average tenure
is therefore not an interesting number. More interesting is the fact that the difference in
CEO tenure between firms with unitary leadership structure is significantly higher than in
firms with a dual leadership structure. Maybe the CEO s who are chairman are doing a better
job, but maybe they are in a better position to entrench themselves in the company.
Duality and firm performance
This last issue also raises the question of the relationship between CEO duality and firm
performance. Over the past years many researchers have tried to link board structure and
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CEO duality to firm performance, unfortunately with almost as many different conclusions
as there are papers written on the topic.
Brickley, Coles and Jarrell (1997) point out that firms with a separate chairman and CEO do
not have an increased (accounting) profit. According to these authors the stock value of
firms switching from a unitary to a dual leadership structure actually decreased.
In contrast to the above conclusion, Palmon and Ward (2001) have shown that a change
from a unitary to dual leadership structure leads to positive abnormal returns for large firms,
but for negative abnormal returns for small firms. Other authors however have again
reached other conclusions. Rechner and Dalton (1991) found that firms with a dual
leadership situation consistently outperformed firms with unitary leadership in the period
1978 to 1983.
The recent research by Fosberg and Nelson (1999) supports both sides. In firms with
significant agency problems the authors show that there is a significant increase in
performance following a change in leadership structure. However, for firms shifting to dual
leadership as part of their succession process show no evidence of changed performance
following the change in structure.
There are also a number of researches that do not show any result of performance due to
CEO duality.33 Most interesting in this field is the paper by Coles and Hesterley (2000) who
write that the inability to show returns one way or the other for either unitary or dual firms
may result from the fact that the separation is used by many researchers as a proxy for
independence. However the authors argue that a dual leadership structure is not a guarantee
for independence.
This last point raises an interesting issue. The general idea behind the split between CEO
and chairman is the fact that it stimulates the board to perform better and more
independently of management. If one is a strong believer in agency theory, it would indeed
seem wise to make an independent (or outside) director chairman of the firm. However, the
33 Finckelstein and d Aveni (2000), p4, have quite an extensive overview on the research regarding this topic.
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fact that there are two different people performing the job of CEO and chairman does not
per se lead to better governance. An independent chairman (or board) would not guarantee
better monitoring and/or performance. Directors simply need to be honest and decent in
their jobs. The firm itself requires a good strategy. A well functioning corporate governance
system is of course important, as it reduces the chances firms can hide bad results.
Up to this point I have discussed the various reasons firms have for choosing a particular
governance model and I have shown what the past and current trends are. In the following
section I would like to go into future developments regarding CEO duality.
Future developments
In my opinion an increasing number of firms will decide to split the functions of CEO and
chairman in the future. I recognize a number of trends and recent events that support this
theory.
First of all there are increasing numbers of corporate governance codes and exchange listring
requirements recommending or even mandating a split in the two jobs. As mentioned the
different codes in the UK strongly urge companies to separate the functions. On the other
side of the Atlantic the results are mixed. The New York Stock Exchange (NYSE) does not
say anything about CEO duality in its listing requirements. However the NYSE itself has
split the function of chairman and chief executive in its own organization.34 Given the old
aphorism you lead by example , the NYSE might well be setting a standard.
Business groups, such as the Business Roundtable or the Conference Board, have conflicting
ideas. The Conference Board urges companies to at least install an independent lead director
if not an independent chairman.35 The Business Roundtable however is very positive about
the American governance model stating that most American corporations are well served
by a structure in which the CEO also serves as chairman of the board. However the
34 The listing requirements were made under the leadership of CEO and chairman Richard Grasso. Some claim that the recent split of these top jobs at the NYSE are due to the situation left by Grasso. 35 The Conference Board (2003), p 19.
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Business Roundtable also writes that every company should make its own judgments
regarding the separation of CEO and chairman.36
Another recent factor which might shift the balance towards more separation of top jobs is
the growing amount of work needed from the top executives at firms to comply with
increasing government laws and regulations. The workload for CEO s and chairmen will
probably increase greatly as an effect of the Sarbanes Oxley Act in the USA and the
Financial Services Action Plan in the EU. It will therefore be increasingly difficult and time
consuming for one person to perform all that work.
The most important group however to mandate a separation, are of course the owners of the
company. Recently there has been an increasing number of investors who demand
separation between the top jobs for them to invest in the firm. While not going as far as
mandating or recommending a split, the California Public Employees Retirement System
(CalPERS) has stated in their 1998 governance principles that the traditional combination of
the jobs should be re-evaluated.37 Other investors go further and do demand a separation. In
a speech made in June 2004, Jan Willem Baud, the CEO of NPM capital, stated that NPM in
the future would only consider investing in companies which adhered to certain corporate
governance practices, one of which was a split in functions between the chairman and the
chief executive.
There has also been an great increase in shareholder proposals urging the adoption of a dual
leadership structure. In the USA in 2002 there were only four such proposals handed in,
while in 2003 there were more than 25 proposals urging the separation between the top jobs.
Most proposals were handed in by labor organizations such as the AFL-CIO, but there are
an increasing number of proposals being handed in by individuals.38
36 Business Roundtable (2002), p 11. 37 Corporate Governance Core Principles & Guidelines (1998), p 10. 38 Taub (2003) http://www.cfo.com/article.cfm/3008374
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Furthermore, in a research by McKinsey (2000) over 80% of investors say they would be
prepared to pay more for the shares of well-governed companies than those of poorly
governed companies. 39
Other McKinsey surveys show that 72% of directors and 69% of investors support a
separation of CEO and chairman. The main opponent in the eyes of the directors to
splitting the jobs is the CEO.40
There is one other important factor that might shift the balance in favor of separation of
CEO and chairman. In the past corporate governance has been seen as a soft topic, with
little direct impact on company performance or cost of doing business. Recently however,
Fitch Ratings, Standard & Poor s and Moody s, all three credit rating agencies, have stated
that they will use corporate governance measurements in determining credit ratings,
including measurements on (non)independent chairmen.
In 2002 another McKinsey survey found that shareholders were prepared to pay a premium
of 14% on stocks of well-governed companies.
Therefore, in the future, good corporate governance or lack of it will have a direct effect
on the cost of capital for the company and the decisions investors make whether to invest in
the company or not. I assume that when more and more institutions base their investment
and rating activities on certain issues regarded as best practices, that the firms eventually will
not be able to resist the pressure to adapt to these best practices. Eventually due to these
factors, the combination of chairmanship and CEO may not be an option.
Up until now I have discussed reasons why the Americans might adopt more dual leadership
structures in their firms. However it might well be that Europeans increasingly adopt the
unitary leadership system. In contrast to the corporate governance codes in place, an
increasing number of European firms are appointing former CEO s as chairmen. The
Financial Times reported that a small majority (16) of Germany s top 30 firms have a former
39 McKinsey & Co (2000) 40 Mckinsey (2003) US Directors Survey And (2004) US Institutional Investors Survey.
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CEO as chairman, with more firms planning to do so soon. The next step the Germans (and
other Europeans) could take is directly appointing their incumbent CEO s as chairman.
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5. Summary and conclusion
In this paper I have researched the degree of CEO duality at S&P 500 and FTSE 100
companies. In 1987 Dalton and Kesner found that 30% of UK companies but 82% of US
companies have the same person as chairman and chief executive. My own research results
from 2004 show that 76% S&P 500 companies have the same chairman as chief executive,
while for FTSE 100 companies, it is only 4%.
Many reasons are given for the absence of a separation in the United States. One of the main
reasons quoted for the difference is the CEO succession method in the USA. I tested this
succession theory by comparing the average tenure for CEO s in different situations. The
average tenure for all companies in the S&P 500 was 6.3 years. In companies with a dual
CEO and chairman, the tenure was higher at 7.2 years. For companies with a different
person as CEO the average was 3.4 years, and even lower for companies with a former CEO
as chairman at 2.7 years. My research shows that in firms with a former CEO as chairman
the incumbent CEO is usually quite new to the job, possibly supporting the succession
theory. The differences in tenure are statistically significant at the 95% confidence level.
But this difference in tenure can also support the entrenchment theory. The above results
show that CEO tenure in firms with a dual CEO and chairman is on average more than
twice as long as in firms where a different person is chairman. Based on these figures, it is
not difficult to support the thesis that duality leads to entrenchment.
Another factor I researched that can point to CEO entrenchment is CEO compensation.
According to my research, firms with a single CEO/Chairman pay that person on average $
2.8 million. For split firms the average is $ 2.63 million with a former CEO as chairman and
even less at $ 2.15 million when the chairman is neither current nor former CEO. Only the
difference in pay between this last group and the group of combined CEO/Chairman is
statistically significant. However, as a single person as both Chairman and CEO is in fact
doing both jobs, I do not find the difference in pay scales between the groups large enough to
support the entrenchment theory on this point.
20
Finally I have looked at trends and movements regarding corporate governance on the point
of CEO duality. In general most trends point to an increase of separation between the jobs
of chairman and chief executive.
First of all, an increasing number of corporate governance codes is recommending a
separation between chairman and chief executive, partially due to the increased workload
following legislation like Sarbanes Oxley in the USA and the Financial Services Action Plan
in the EU.
Secondly, an increasing number of shareholders are urging the adoption of a dual leadership
structure. An increasing number of proposals are being handed in at shareholder meetings
urging the separation, and institutional investors are increasingly demanding that companies
adhere to certain corporate governance best practices including separation of CEO and
chairman before they invest in a company.
Thirdly there is the fact that corporate governance is starting to affect the cost of doing
business for companies. Credit rating agencies are increasingly using certain governance
measurements in determining the credit rating for companies. Surveys have also found that
investors are prepared to pay a premium for well governed companies. Both groups
appreciate separating the two top jobs.
However, while it is useful, the separation of chairman and chief executive per se does not
lead to better governance. Investors are wise to keep that in mind.
21
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Brickley, J.A., Coles, J.L., Jarrell, G., 1997, Leadership Structure: Separating the CEO and Chairman of the Board . Journal of Corporate Finance 3, 189-220.
Brickley, J.A., James, C.M., The Takeover Market, Corporate Board Composition, and Ownership Structure: The Case of Banking . Journal of Law & Economics, Vol 30, No 1, 161-180.
Business Roundtable, 2002, Principles of Corporate Governance . White Paper.
Cadbury, A. et al, 1992, Report of the Committee on the Financial Aspects of Corporate Governance .
California Public Employees Retirement System, 1998, Corporate Governance Core Principles & Guidelines .
Campbell, A., 1995, The Cost of Independent Chairmen . Long Range Planning, Vol. 28, No. 6, 107-108.
Carapeto, M., Lasfer, M., Machera, K., 2004, Does the splitting of the roles of CEO and Chairman create value? . Paper for Second European Academic Conference on Internal Audit and Corporate Governance, Cass Business School, 22-23 April 2004.
Coles, J.W., Hesterly, W.S., 2000, Independence of the Chairman and Board Composition: Firm Choices and Shareholder Value . Journal of Management, Vol. 26, No. 2, 195 214.
Collier, P., Gregory, A., 1999, Audit Committee Activity and Agency Costs . Journal of Accounting and Public Policy 18, 311-332.
Condit, M.B., Hess, E.D., 2003, Is it Time for the Non-Executive Chairman? . The Corporate Board, Jan/Feb 2003, 1-4.
Conference Board, 2003, Commission on Public Trust and Private Enterprise . Findings and Recommendations. http://www.conference-board.org/
Dalton, D.R., Kesner, I.F., 1987, Composition and CEO Duality in Boards of Directors: An International Perspective . Journal of International Business Studies, Vol 18, No 3, 33-42.
Davis Global Advisors, 2002, Leading Corporate Governance Indicators 2002 . http://www.davisglobal.com/
22
Dedman, E., 2002, The Cadbury Committee Recommendation on Corporate Governance
A Review of Compliance and Performance Impacts . International Journal of
Management Reviews. Volume 4, Issue 4, 335-352.
Donaldson, L., Davis, J.H., 1991, Stewardship Theory or Agency Theory: CEO Governance and Shareholder Returns . Australian Journal of Management, Vol 16, No 1, 49-65.
Fama, E.F., Jensen, M.C., 1983, Separation of Ownership and Control . Journal of Law and Economics, Vol. 26.
Financial Reporting Council, 2003, Combined Code on Corporate Governance . http://www.asb.org.uk/
Finkelstein, S., D Aveni, R.A., 1994, CEO Duality as a Double-Edged Sword: How Boards of Directors Balance Entrenchment Avoidance and Unity of Command . The Academy of Management Journal, Vol 37, No 5, 1079-1108.
Fosberg, R.H., Nelson, M.R., 1999, Leadership Structure and Firm Performance . International Review of Financial Analysis, Vol 8, 83-96.
Harrison, J.R., Torres, D.L., Kukalis, S., 1988, The Changing of the Guard: Turnover and Structural Change in the Top-Management Positions . Administrative Science Quarterly, Vol 33, No 2, 211-232.
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Jensen, M.C., Meckling, W.H., 1976, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure . Journal of Financial Economics, Vol 3, No 4, 305-360.
Keenan, J., 2004, Corporate Governance in UK/ USA Boardrooms . Corporate Governance, Vol 12, No 2, 172-176.
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Lucier, C., Schuyt, R., Handa, J., 2003, CEO Succession 2003: The Perils of Good Governance , Booz Allen Hamilton.
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23
Morck, R., 2004, Behavioral Finance in Corporate Governance Independent Directors and Non-Executive Chairs . Harvard Institute of Economic Research Discussion Paper Number 2037.
New York Stock Exchange, 2004, New Governance Architecture . http:/ / www.nyse.com/
Organisation for Economic Co-operation and Development, 1999, OECD Principles of Corporate Governance . http:/ / www.oecd.org/
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Peters, J.F.M. et al, 1997, Corporate Governance in Nederland. De Veertig Aanbevelingen .
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Vancil, R.F., 1987, A Look at CEO Succession . Harvard Business Review, Vol 65, No 2, 107-117.
24
Appendix 2: Statistics
All statistics were compiled with the Analysis ToolPak included in Microsoft Excel XP using the t-Test: Two-Sample Assuming Unequal Variances . The confidence level is 95% and ** denotes statistically significant at the aforementioned confidence level. For clarity, numbers have been rounded off to three decimals.
CEO Tenure
Chairman is: CURR CEO NOT CURR CEO Mean tenure 7,196
3,403
Variance 52,295
16,243
Observations 367
119
Hypothesized Mean Difference 0
Df 365
t Stat 7,181
P(T<=t) one-tail ** 1,957 E-12
t Critical one-tail 1,649
CURR CEO ALL FIRMS Mean tenure 7,196
6,267
Variance 52,295
46,081
Observations 367
486
Hypothesized Mean Difference 0
df 761
t Stat 1,906
P(T<=t) one-tail ** 0,0285
t Critical one-tail 1,647
CURR CEO FORMER CEO Mean tenure 7,196
2,652
Variance 52,295
4,407
Observations 367
69
Hypothesized Mean Difference 0
df 369
t Stat 10,003
P(T<=t) one-tail ** 2,649 E-21
t Critical one-tail 1,649
25
NOT CEO FORMER CEO Mean tenure 3,403
2,652
Variance 16,243
4,407
Observations 119
69
Hypothesized Mean Difference 0
df 184
t Stat 1,678
P(T<=t) one-tail ** 0,0475
t Critical one-tail 1,653
CURR CEO NOT CUR/FMR CEO
Mean tenure 7,196
4,440
Variance 52,295
31,109
Observations 367
50
Hypothesized Mean Difference 0
df 73
t Stat 3,152
P(T<=t) one-tail ** 0,001
t Critical one-tail 1,666
CURR/FMR CEO NOT CUR/FMR CEO
Mean 6,477
4,440
Variance 47,445
31,109
Observations 436
50
Hypothesized Mean Difference 0
df 67
t Stat 2,383
P(T<=t) one-tail ** 0,010
t Critical one-tail 1,668
26
CEO Compensation
CURR CEO NOT CEO
Mean compensation $ 2.803.080
$ 2.426.292
Variance 6,198 E+12
9,498 E+12
Observations 367
119
Hypothesized Mean Difference 0
df 171
t Stat 1,212
P(T<=t) one-tail 0,114
t Critical one-tail 1,659
CURR CEO ALL FIRMS Mean compensation $ 2.803.080
$ 2.710.821
Variance 6,198 E+12
7,014 E+12
Observations 367
486
Hypothesized Mean Difference 0
df 812
t Stat 0,521
P(T<=t) one-tail 0,301
t Critical one-tail 1,647
CURR CEO FORMER CEO Mean compensation $ 2.803.080
$ 2.627.319
Variance 6,198 E+12
1,427 E+13
Observations 367
69
Hypothesized Mean Difference 0
df 79
t Stat 0,372
P(T<=t) one-tail 0,356
t Critical one-tail 1,664
NOT CEO FORMER CEO Mean compensation $ 2.426.292
$ 2.627.319
Variance 9,498 E+12
1,426 E+13
Observations 119
69
Hypothesized Mean Difference 0
df 120
t Stat -0,3756
P(T<=t) one-tail 0,354
t Critical one-tail 1,658
27
CURR CEO NOT CUR/FRM CEO
Mean compensation $ 2.803.080
$ 2.148.875
Variance 6,198 E+12
2,944 E+12
Observations 367
50
Hypothesized Mean Difference 0
df 80
t Stat 2,377
P(T<=t) one-tail ** 0,010
t Critical one-tail 1,664
CURR/FMR CEO NOT CUR/FRM CEO
Mean $ 2.775.264
$ 2.148.875
Variance 7,449 E+12
2,944 E+12
Observations 436
50
Hypothesized Mean Difference 0
df 81
t Stat 2,273
P(T<=t) one-tail ** 0,013
t Critical one-tail 1,664