Post on 09-Feb-2017
7/30/2015
CEO Duality and Corporate Performance
Agency or Stewardship?
Byron MainUniversity of saint thomas
1
Byron Main
Table of ContentsIntroduction 2
Agency Theory 2-5
Form 3
Advantages 3-4
Hypothesis 1 4
Disadvantages 4-5
Stewardship Theory 5
Form 5
Advantages 5-6
Hypothesis 2 6
Disadvantages 6
Factors 6
Informal CEO Power 6-7
Hypothesis 3 7
Firm Performance 7-8
Hypothesis 4 8
Competition 8
Hypothesis 5 8
Additional Factors 8
Hypothesis 9
1-5 9
Final Hypothesis 9
Measuring Firm Performance 9-10
Formula (Elsayed) 10
Formula (Yang) 10
Research Design and Results 10-26
Elsayed design 10-14
Finkelstein design 14-19
Yang design 19-26
Conclusion 26-27
Footnotes 28-29
2
Byron Main
Introduction:
With the rise of global interconnectivity, and multinational corporations that span whole
continents, engaging with consumers the world over, “the impact of board leadership structure…on
corporate performance “1 has come into the spotlight. The main focus is on the concept of the duality
CEO (i.e. one who holds both the Chief Executive Officer and Chairman of the Board). Two main notions
on the view of CEO duality are Agency and stewardship theories, which will be further explained below.
The following paper will show how a number of factors including company financials, industry, areas of
business, company size etc. are affected by CEO duality and with performance indexes providing sound
evidence will conclude that both the agency and stewardship theories are valid given certain situations
(contingency theory). Thus firm performance is influenced very little by CEO duality and more so by
cornucopia of components though four key factors such as market environment (competition), industrial
activity, firm performance, informal CEO power (influence within the company) are the most influential
of all the determinants.
Agency Theory:
To begin, is the concept of agency theory what some refer to as vigilant corporate governance.
In the eyes of many a comprehensive and overarching management in the modern era of MNC’s (Multi-
National Corporations) is an absolute necessity to prevent as Jensen and Meckling stated in their 1976
essay a single agent (some refer to as duality CEO) from seeking “to maximize his wealth at the expense
of the shareholders’ value”2. A continuation of this belief was presented by Mallin in 2001 who
expressed that “without good corporate governance both corporate performance and the investors’
3
Byron Main
money may be at risk”3. To that end agency theory put simply “Bearle and Means (1932) is the
separation of ownership from management “4. Essentially in corporate governance it boils down to “a
contract under which one or more principals engage another person (the agent to perform some service
on their behalf which involves delegating some decision making authority to the agent” 5. As previously
stated, an agent unrestricted will attempt to maximize own personal happiness, therefore the principle
from the preceding example must ensure some sort of oversight over company decisions.
Form:
The most common form of agency theory in modern corporations is the separation of the CEO
(chief executive officer) and the COB (chairman of the board). Of course with each corporation
responsibilities between the COB and CEO will vary. However in most cases the chairman of the board
runs the board of directors, deals with external funding, sets forth compensation plans, CEO succession
and strategic plan guidance. Meanwhile the Chief Executive Officer handles “strategic process,
operating process, organizational process” 6. Moving forward “Agency theorists have identified boards of
directors as a primary monitoring device protecting shareholder interests” 7. Effective (vigilant) boards
tend to be composed of “a large group of independent, outside directors...individuals not otherwise
associated with the corporation” 8; and tend to own a large percentage of the held stock. One example is
Warren Buffett (CEO of Berkshire Hathaway), who has either himself or a proxy on nearly every single
one of the companies to which he owns more than 5% of the outstanding stock (i.e. Duracell, Coca Cola).
Advantages:
Outside board members are more effective than those promoted from within the company for
three reasons: Firstly the focus in purely on financial, and long term viability of the company. Second; if
performance is low they are more likely to call for a change in strategy/ managers for the firm. Thirdly,
they are not beholden to the CEO, for their promotion and thus have the freedom to act without the
4
Byron Main
worries of retributive action. There are a growing number of reasons why many scholars and business
professionals feel that agency theory (non-duality CEO) is in fact the only viable form of corporate
management structure. Firstly one of the main factors as stated above is that most firms today operate
on a global scale and require, an agent to carry out tasks, so some sort of oversight of the agent on
behalf of the principle is necessary. A second important factor has been the “growing number of
financial and accounting scandals that have occurred in several modern corporations”9 (e.g. WorldCom,
Enron, Wachovia). In the case of Enron it was a systematic failure of the board to watch over Kenneth
Lay who was a Duality CEO and appointed most of the board members from within the ranks of the
company itself. Another reason for the rise of agency theory is government regulations set out by “U.S.
securities and exchange commission (SEC) and the Dodd-Frank Act require listed firms effective 2010 to
disclose reasoning behind the board leadership structures” 10.
Hypothesis (1): In less competitive market environments, larger firms tend to embrace agency
theory and stringent monitoring to compensate for lower levels of agent discipline from market
competition.
Disadvantages:
With the above being stated there remain several issues with the implementation and use of
agency theory. The primary problem is that of agency costs, which are defined as those costs borne by
shareholders to encourage managers (agents) to maximize the wealth of shareholders over their own
self-interest. There are three types of agency costs: “1) expenditures to monitor managerial activities,
such as audit costs; 2) expenditures to structure the organization in a way that will limit undesirable
managerial behavior…3) opportunity costs which are incurred when shareholder-imposed restrictions,
such as requirements for shareholder votes on specific issues limit the ability of managers to take
actions that advance shareholder wealth” 11. These costs are always passed unto the shareholder and
5
Byron Main
therefore represent a necessary but unfortunate cost. Two other costs that are also heightened with
agency theory is that of information specificity costs (specific information that gives firms a higher
market power) and information immediacy costs (costs for loss opportunities resulting from information
becoming obsolete). Each of the above costs is higher when a management structure follows agency
theory for there is an extra chain of command and separation of responsibilities, slowing down response
time to new information and situations. Lastly in agency theory is the issue of monitoring the board and
COB themselves (who watches the watcher).
Stewardship Theory:
Stewardship theory, is the other side of the coin from agency theory. Within corporate
governance stewardship theory unlike agency assumes that the agent will in fact align their actions in
line with the wishes of a principle. Agents are seen as essentially loyal to a company and will do anything
to achieve a high company performance.
Form:
Agents who participate in stewardship theory are most often referred to as duality CEO’s, for
they fulfill both the position of CEO (chief executive officer) and COB (chairman of the board) the
common responsibilities of each was outlined in the paragraph above.
Advantages:
Continuing on, there are several key advantages to having one person fulfill both of the
aforementioned positions. Firstly CEO duality “establishes a strong and unambiguous leadership” 12,
which would allow for an uninterrupted chain of command and unambiguous authority over all aspects
of a situation. Also may CEOs “may often have the best specific knowledge of the strategic challenges
and opportunities facing the firm” 13. In addition the “strong CEO leadership can help firms adapt to
6
Byron Main
environmental demands” 14. This last point would be exemplified by the “exogenous shock…
implementation of the 1989 Canada-United States Free Trade Agreement (FTA) which increased the
competition of U.S. firms by eliminating all tariffs and other trade barriers between the U.S. and
Canada”15. Through various studies across all industries it was found that on average duality firms
outperformed firms following agency theory by a margin of three percent after the (FTA) went into
effect 16 Also having one manager in charge is that it confers upon the shareholders of the company and
the public at large a sense “legitimacy, sending a signal…that a firm has a clear sense of direction”17. This
signal of continuity can “create an illusion of stability and a sense that a dominate leader, not the
environment, is determining organizational destiny” 18. Also, having one agent in charge lessons the
agencies costs that would be incurred upon an organization with a non-duality structure.
Hypothesis (2): Firms with duality CEO’s innovate and adapt more quickly to new information, at
less cost than firms possessing separate CEO and chairman of the board.
Disadvantages:
However stewardship theory and the duality CEO are not without issues. As stated in the above
paragraph an agent acting as a duality CEO may put personal gain over company performance. Also
having a duality CEO increases the risk of entrenchment which may as stated before “lead to
opportunistic and inefficient behavior that reduces shareholder wealth” 19. Finally, having only one agent
in control can lead to static behavior by a corporation, whereupon only one set of ideas is pursued even
if they may not be in the corporations’ principal interest
Factors:
Informal CEO Power: is derived from sources of influence not directly tied into the
responsibilities relating to the CEO’s official position. CEO’s tend to garner their informal power through
key sources for instance “developing prestigious contacts with other organizations…managing critical
7
Byron Main
organizational problems…engendering loyalty within their organizations…and co-opting boards of
directors”20. High amount of informal power can be tantamount to CEO duality, as well as be a cause for
entrenchment within the firm. Given the previous statement vigilant boards tend to be very wary of
CEO’s with high amounts of informal power, and thus reducing their own influence over the firm,
therefore many boards would choose an independent board chairperson to counteract the high
informal power retained by the CEO.
Hypothesis (3): CEO duality will tend to be lower when a CEO possesses high informal power,
with the existence of an independent vigilant board.
Firm Performance: Both Finkelstein and Khaled Elsayed see firm performance as a key indicator
whether a firm chooses duality CEO or not. Overall firm profitability is an indication of whether the
CEO’s strategic policies are effective. According to Finkelstein “when firm performance is good, strong
boards may seek to avoid” 21 a duality CEO for this runs the risk of entrenchment. A few reasons for this
are as follows. Firstly high performance tends to enhance the status and informal power of the CEO.
Next it creates organizational slack which CEO’s may use to benefit themselves or those beneath to
engender personal loyalty. Thirdly “because attributions of CEO effectiveness are often made when
firms are successful…there is less need to create a sense of managerial efficacy through duality…
stakeholders may already perceive firms operations as legitimate” 22. Lastly boards whose firms are high
performing are less likely to fire the CEO, whom many perceive to be responsible for the good fortunes
of the firm. However CEO duality can be valued by vigilant boards when overall performance is low, so
as to have one overall voice in command so that the implementation of a turnaround strategy occurs
unimpeded. There are many ways of measuring firm performance some of them will be mentioned in
the subsequent sections. At this moment Finkelstein’s definition must suffice with firm performance
8
Byron Main
being “measured by return on assets (ROA), a common indicator of short-term performance, calculated
as net income divided by total assets”23.
Hypothesis (4): Strong performance by a firm with a vigilant independent board will result in
lower levels of CEO duality.
Competition (Yang): Competition, more specifically how well a company within an industry fares
in various levels of competition. The situation being utilized was mentioned in the above paragraph on
stewardship theory as the passing Canada-United States Free Trade Agreement of 1989 which removed
all barriers between the two nations. This agreement instituted the world’s largest “bilateral trade
between Canada and the U.S.”24. The new Canadian imports tended to compete directly with products
provided by U.S. based firm, the FTA become “associated with substantial employment loss, labor
productivity gains, and reduction in price-cost margin” 25. The preceding statement suggests that the FTA
brought increased competition to U.S. firms therefore is a perfect measure for how CEO duality will
effect firm performance in differing levels of market competition.
Hypothesis (5): Firms following stewardship theory will be more common and outperform firms
following agency theory, whenever there is a significant increase in competition, in the market
environment.
Additional Factors: The following factors will either be controlled for or utilized in the formulas
that the research experiments below are based on.
Firm Size- how large a firm is in relation to its sales. “Measured as the natural logarithm of net sales…total assets and number of employees are two alternative measures” 26 that may be utilized if net sales is not available.
Non-Production overhead- “This variable is measured as the ratio of general, selling, and administrative expenses to sales” 27.
CEO shareholdings: is the proportion of a firm’s total shares owned by the CEO. Industry segments: utilized when trying to examine just one particular industry segment
across multiple companies with every firm having multiple industry segments. Therefore dummy variables are created for industry segments that are not part of the analysis.
9
Byron Main
CEO duality- give variables to firms on the basis of either following agency or stewardship theory. For agency value=0, stewardship value=1
Board size- number of directors sitting on the board Institutional ownership- refers to the ownership stake in a firm that is being retained by
financial organizations, endowments, or pension funds (CalPERS). Organizations such as these routinely purchase great quantities of a firms outstanding shares and thereby wield considerable influence on management.
Debt ratio (Elsayed) - can be shown as the ratio of total debt to total assets. Capital Intensity (Elsayed) – is the ratio of net fixed assets to total assets.
Revised Hypothesis:
1) In less competitive market environments, larger firms tend to embrace agency theory and stringent monitoring to compensate for lower levels of agent discipline from market competition. Yang 15
2) Firms with duality CEO’s innovate and adapt more quickly to new information, at less cost than firms possessing separate CEO and chairman of the board.
3) CEO duality will tend to be lower when a CEO possess high informal power, with the existence of an independent vigilant board.
4) Strong performance by a firm with a vigilant independent board will result in lower levels of CEO duality.
5) Firms following stewardship theory will be more common and outperform firms following agency theory, whenever there is a significant increase in competition, in the market environment.
Final Hypothesis (overall): There is not one optimal leadership structure (i.e. agency or stewardship theory), as both have costs and benefits that will succeed under the right conditions of competition levels (duality better at higher levels), industrial activity, current financial performance, informal power of CEO. However overall companies with duality CEO’s do tend to perform better than those with separated leadership.
Measuring Firm Performance:
One of the main issues with measuring the effectiveness of CEO duality (stewardship theory), in
fact there are two prevailing ways of measuring firm performance. One is accounting based as
championed by Muth and Donaldson in 1998, while the second and more widely accepted is the use of
market valuation measures especially that of Tobin’s q ratio, which was first introduced by Barnhart and
Rosenstein in 1998 29. Tobins q, readily defined as the “ratio of a firm market value to the replacement
cost of its assets” 30. Additionally, many have argued that it is far more appropriate because it “is a long
term measure that takes risks and return dimensions into account and reflects the firm’s ability to
improve performance over time”31.
10
Byron Main
Formula (Elsayed):
Tobin q values:
Equilibrium: q= 1 Higher than expected investment opportunities: q>1 Less profitable than expected investment opportunities: q<1
Tobin q formula as used by Elsayed and formulated by Chung and Pruitt:
Tobin’s q ratio= [MV +BV of preference capital +BV of long term debt + BV of Inventory + BV of Current Liabilities – BV of Current Assets]/ [TA].
o MV= market valueo BV= book value
The second formula for measuring Tobin’s q that will be used as a measurement of firm performance
with an increase in competition is Tina Yang’s seminal formula.
Formula (Yang):
Tobins Q= y1tariffi*post89*duali + y2tariffi*post89 +tXit + dt + di + ∑it
i= index firms dt= denotes time, t= 1979-1998 di= denotes firm fixed effects tariffi= avg. U.S. tariff rate on Canadian imports for firm i between 1986-1989. Post89= 1 if t>1989 otherwise=0 Duali= 1 if firm has a stable board leadership structure of CEO being the COB (Duality CEO), zero
otherwise X= firm characteristics i.e. firm size, ROA, capital structure, and risk TA= total assets
Research Designs and Results:
In the following section a series of research designs will be used to prove the hypothesis
discussed in an aforementioned paragraph.
Khaled Elsayed:
11
Byron Main
The first measuring corporate performance, comes from Khaled Elsayeds’ paper Does CEO
Duality Really Affect Corporate Performance. In this essay to determine whether CEO duality had any
impact on performance Elsayed used a sample of firms from the “Egyptian Capital Market Agency over
the time period 2000 to 2004”32. In this study using the above mentioned Chung/ Pruitt formula for
Tobin’s q along with board leadership structure as independent variable (1=CEO duality, 0=otherwise),
corporate performance as the dependent variable. In addition several key factors are considered and
controlled for including ‘corporate size, debt ratio, capital intensity’ all discussed in a previous
paragraph. Table 1 below has descriptive statistics for all variables used or controlled for in Elsayed’s
experiment.
Given the above statistics Elsayed attempts to estimate the impact CEO duality may have on overall firm
performance. To test this main hypothesis a Least Absolute Value model must be utilized in place of a
traditional ordinary of least squares on both ROA, and Tobin’s q due to the fact that (OLS) is far to
affected by extreme outliers in observation, a flaw that the Least Absolute Value (LAV) model does not
share. In the LAV model the median of dependent variable (firm performance) can be estimated
through “the raw sum of absolute deviations around the unconditional median to find the regression
coefficient that minimize regression functions” 33. In other words the LAV model selects parameters that
mitigate any absolute residuals. Table 3 below will show the LAV regression with CEO duality as
12
Byron Main
independent variable and firm performance shown by proxy with ROA and Tobin’s q ratio substituted in
its place as the dependent variables.
13
Byron Main
From the LAV regression above it is clear that CEO Duality has almost no impact on firm performance as
demonstrated by ROA and Tobins q with values of 0.9483 and 0.0154 That is significantly contrasted to
institutional ownership whose values are 0.0467 and 0.008 which both fall within the desired range of
values (i.e. p<0.10, p<0.010, p<0.001. However this LAV regression did encompass multiple industries
which could throw off many of the values, especially if some had positive values while others did not.
Saying that Table 4 breaks everything down by industry. In the following table it is seen that while 5
industries had generally positive coefficients for Tobins q and thus firm performance there were several
that either had negative (cement) or insignificant (steel, constructions, communication etc.) coefficients.
Table 4 may imply that CEO duality is indeed positively correlated with certain industries and negative
with others. However there are far too many other possibilities for these trends to say that CEO duality
alone was the cause for overall firm performance. Other possibilities may include that most boards with
high performing firms would not wish CEO duality to occur as explained earlier in the paper. With this
14
Byron Main
belief in mind all industries are separated into coefficient values (i.e. positive, negative, or insignificant.
This separation is shown in Table 5 below.
15
Byron Main
As can be seen from Table 5 above CEO duality has a greater impact on low performing sub-group ROA=
1.512) relative to the high group (ROA=0.982). This would give credence to hypothesis 4: Strong
performance by a firm with a vigilant independent board will result in lower levels of CEO duality.
Finkelstein and D’vani:
The second experiment was designed by Sydney Finkelstein and Richard A. D’Aveni unlike the
preceding Elsayed did not focus on a sample of large firms across industries (i.e. ECMA). Instead
choosing to focus single industry studies for a few key advantages. Firstly, for the “differences affecting
how variable interact with environmental contingencies are controlled for with greater accuracy” finkelstein
1089. In addition within single industry studies intrainindustry heterogeneity can is more easily realized.
Lastly single industry studies represent the perfect platform to test new ideas due to the high validity of
information garnered from research. To the actual experiment itself, Finkelstein and D’Aveni ran it much
like Elsayed did above with the exception already stated of only examining on an industry, not a market
wide level. To this end, the printing and publishing, computers, chemical industries were each analyzed
separately, to test the validity of their hypothesis about CEO duality since each industry “face different
critical success factors and have somewhat different propensities to CEO duality” Finkelstein 1090. Now onto
the actual form of the study group itself which as stated previously consisted of all firms (public) whose
16
Byron Main
primary market segment was chemicals, printing and publishing, or computers “according to Ward’s
Directory from 1984 through 1986” 34. That being said firms were not present on in the study if one or all
of the following requirements went held true. First “They were subsidiaries of other firms, (2) they had
more than 50 percent of their sales in businesses outside of their primary business… (3) data were not
available” 34. In the end a total of 41 firms (printing and publishing), 35 firms (chemical), and 32 firms
(computers) were analyzed over a three year period with 107, 102, and 91 observations for each of the
industries respectively. This study used a set of seven factors to measure how common CEO duality was
within each industry the results of which are in the tables below, with CEO duality as the dependent
variable.
17
Byron Main
Table 1 above shows all the descriptive statistics for variables in the printing and publishing
industry, while table 2 below has descriptive statistics for the combined chemical and computer industry
segments.
Now granted without logistic regression analysis, results from the two above tables cannot be fully
formed. However two minor observations can be taken with a cautionary mind. Firstly, observations of
CEO duality among the three market segments was significantly lower than the fortune 500 (years 1984-
1986 of 82percent. Whereas CEO duality was 56 percent for the printing and publishing segments; 62
percent for the combined chemical and computer industries. Secondly “correlations between board
vigilance and CEO duality were positive for both groups of firms” 34. Regardless of the previous
statement nothing can be certain until regression analysis both on the printing and publishing, as well as
18
Byron Main
the combined computer, chemical segment is performed the results of which can be found below on
pages 17-18.
19
Byron Main
20
Byron Main
21
Byron Main
As previously noted the man goal of this study was the relationship between boards of director and CEO
duality. Therefore the results from the above tables show the coefficient values of factors relate back to
CEO Duality. Take for example Model 5 on tables 3 and 4, under the informal CEO power and ROA tabs.
In both cases the numbers (coefficient) is positive (Model 5 Table 3 ROA= 0.082, CEOIP=0.180), meaning
that the higher return on assets as well as high informal power by the CEO would result in firms less
likely following agency theory. Firm would be more likely to follow if the interaction terms were
negative. Essentially depending on the sign of the interaction terms in relation to the vigilant board,
duality may be more or less likely to occur. Additionally, several other important facts came to light. The
first being in a model where interaction terms (informal CEO power, ROA etc.) board vigilance and CEO
duality had positive correlations. “When other influences held constant…vigilant boards are more
concerned with unity of command than with entrenchment avoidance”35. Secondly, when CEO informal
power is very high vigilant boards shift their focus away from unity of command and begin practicing
agency theory to avoid entrenchment.
Tim Yang, Shan Zhao:
The last study that will be utilized comes from the aforementioned Tim Yang, and Shan Zhao in
their essay CEO Duality, Competition, and Firm Performance. Their essay centers on the core belief that
after the application of an exogenous shock (i.e. unexpected event), firms following stewardship theory
(duality CEOs) tend to perform better than those with separated leadership. The study focused on U.S.
firms who were directly affected by the Canada-United States Free Trade Agreement of 1989 (the
exogenous shock). As previously stated the FTA increased competition for U.S. firms by significantly
lowering or eliminating all trade barriers with Canada. Like Elsayed, Yang and Zhao utilize Tobin’s q.
However their purpose is to create a “baseline model to estimate the impact of board leadership
structure on firm value” 36 given an exogenous shock. The formula above mentioned is as follows:
22
Byron Main
Formula (Yang):
Tobins Q= y1tariffi*post89*duali + y2tariffi*post89 +tXit + dt + di + ∑it
i= index firms dt= denotes time, t= 1979-1998 di= denotes firm fixed effects tariffi= avg. U.S. tariff rate on Canadian imports for firm i between 1986-1989. Post89= 1 if t>1989 otherwise=0 Duali= 1 if firm has a stable board leadership structure of CEO being the COB (Duality CEO), zero
otherwise X= firm characteristics i.e. firm size, ROA, capital structure, and risk TA= total assets
Yang’s formula allows the use an exogenous shock such as the FTA of 1989, to study the effect of
endogenous choice (i.e. board leadership structure) will have on overall firm performance as
competition increases. This is done by comparing performances of duality and non-duality firms affected
by the liberalization of trade restrictions courtesy of the FTA, to the performances of duality and non-
duality firms that are not affected by Free Trade Agreement of 1989. This action will mitigate the
unwanted information courtesy of unobserved heterogeneities between stewardship (duality) and
agency (non-duality) firms. Next a few restrictions (controls) that will mitigate the issue of endogenously
turnover of all firms are as follows. Firstly only firms with stable leadership (board) that existed pre FTA
of 1989 will be considered. A board is considered stable “if it does not change leadership (dual) for more
than 80% of firm years for a minimum of four years from 1988 to 1998 37. Additionally for firms with 5-9
years of board data, leadership can only be different in one of the sample years, and for 10 years the
board leadership status can only be different in two years. Also a firm “cannot be a utility or a financial
institution, has positive values of total assets and net sales, has daily stock returns for at least one
quarter of the fiscal year…and has Compustat data before 1989. After meeting all these requirements
the final sample contained 1,927 (1,181 dual leadership, 746 separate leadership) firms observed during
the 1979 to 1998 time period for a total of 27,345 between the two categories. Following the previous
statement, is a return to Tobin’s q which is the primary measure of firm performance, for it states the
23
Byron Main
net effect of changes in all of a firm’s aspects. Additionally the impact of ROA (return on assets), ROE
(return on equity), as well as market share on duality are reported. However like Elsayed controls are
put in place for all other descriptive characteristics that may affect Tobin’s Q. These being firm size,
current-year ROA, growth opportunities, capital structure and many others which are laid out below in
Table 1.
Variable Name Variable Description [computation presented using WRDS variable names]Tariff Average US tariff rate on Canadian imports for a firm from 1986 to 1988. Operationally, we first obtain the
average tariff rate for each U.S. industry on Canadian imports at the 4-digit SIC level for 1986-1988. We then compute firm-level tariff rates, by multiplying the industry-level tariff rate with the percent of the firm’s segment sales over the firm's total sales and then summing those products. We obtain the data on segment sales from Compustat Segment provided by the Wharton Research Data Services (WRDS).
Dual
Firm operating characteristics
Dummy variable that equals one, if the firm has a stable duality status for 1988-1998; or zero, if the firm has a stable non-duality status for 1988-1998.We define a firm as having a stable duality (non-duality) status, if the firm has a CEO (a director other than the CEO) as the Chairman of the Board (COB) for more than 80% firm years for a minimum of four years from 1988 to 1998.
Tobin's Q Market value of common equity minus book value of common equity plus book value of total assets, over book value of total assets [(prcc_f*csho-ceq+at)/at]
Firm size Natural logarithm of total book assets [ln(at)]
Return on assets (ROA) Earnings before interest, taxes and depreciation (EBIT) over book value of total assets [(oiadp+dp (if not missing))/at]
Return on equity (ROE) EBIT over common equity [(oiadp+dp(if not missing))/ceq]
R&D ratio R&D expenditure over sales [xrd/sale]; xrd=0, if missing.
Debt ratio Long-term debt over total assets [dltt/at]
Volatility Standard deviation of daily stock returns*the square root of 252We compute stock return volatility if the stock was traded for at least a quarter of the year.
Ratio of intangible assets Intangible assets over total book assets[intan/at]; if negative, then zero (one such observation)
Ratio of advertising expense Advertising expense over sales[xad/sale]
Ln(#business segments) Natural logarithm of the number of business segments, in which the firm operatesAltman z-score Altman (1968) z-score, as modified by MacKie-Mason (1990)
[(3.3(oiadp+dp (if not missing))+sale+1.4*re+1.2*(act-lct)))/at]Change in market share Sales growth minus the industry-year average (Frésard (2010))zCash The cash-to-assets ratio minus industry-year mean, over the industry-year standard deviation (Fresard
(2010)). Sales per employees Sales over total number of employees
[sale/(emp*1000)]Overhead expense Selling, General and Administrative Expense over sales
[xsga/sale]
24
Byron Main
Input costs Costs of goods sold over sales [1-cogs/sale]
Wage Employee wage[(xlr*1000)/emp]
%DualBoard size%Outsider%D&O %Institution own
Percent of firms with stable duality statusTotal number of directors on the boardPercent of non-executive directors on the boardPercent of director and officer ownership
Percent of institutional ownership
Moving forward Table 2 panels A shows “key characteristics for 1,927 unique firms from 1979 to 1998,
partitioned by whether a firm is protected by U.S. tariff on Canadian imports (Tariff>0) prior to 1989.
25
Byron Main
Variables are as described in Table 1. R&D is winsorized at 99%. ROE and sales growth are winsorized at
1% at both tails” 43.
From Panel A above, it is clear that firms whose products are protected by tariffs tend to be larger, and
more diversified than their unprotected brethren. Protected firms also tend to have higher ROA(A) 8%
before 1989, than unprotected firms(B) 7.32% That being said unprotected firms have higher Tobin’s q
mean: A=1.70 compared to B=1.61. Additionally these unprotected firms usually have higher sales
growth and more volatility in the stock mean B= 48.46%, mean A=46.27%. Most likely based upon
company performance as well as investor confidence. However for firm A when tariff is taken away ROA
decreases to 6.12%, while stock volatility increases to 55.75%.
One the other hand “Panel B reports summary statistics of key governance variables for 1988-1998, the
time period for which governance data are available. Test statistics for differences in mean (Mean dif)
are based on two-sample t-test. Test statistics for differences in median (Median dif)” 39.
The above image shows a positive correlation between tariff protection and board size, also there tends
to be a higher percentage of outsiders on boards of firms that have tariff protection 66.64% compared
to 61.40% for firms not under tariff protection. Lastly fewer boards under tariff protection have duality
26
Byron Main
CEO’s with only 61.78% compared with firms not under protective tariff where duality CEO’s make up
63.122% of all leadership structures, a 1.44% observable difference. Finally the main results, the impact
of duality on Tobin’s q. Firstly Tobin’s q is reported and utilized as a median value to minimize the effect
brought on by extreme outliers. According to Tina Yang “for the entire sample of 27, 345 firm-year
observations the mean value of Q is 1.73 and median is 1.31 with a standard deviation of 1.65”. Table
three below reports regression estimation of the impact of board leadership on overall firm
performance, with all models taking into account control for firm-level clusters.
27
Byron Main
Table 3, as mentioned in the preceding statement deals with duality’s impact on firm performance,
using Tobin Q as a measure. Column (1) is a baseline and the coefficient of variable interest
tariff*post89*dual is highly positive, which gives evidence that duality performs better as competition
increases. Columns (3) and (4) are the actual validity test. In (3) tariff*post89 is applied to Tobin’s,
Column (4) is the same thing except instead of tariff*post89 it becomes tariff*post88; post88 has a value
of one (dummy variable). Column (3) tariff*post89 is both a significant and positive value, whereas the
control in column (4) tariff*post88 is quite low and insignificant thus the study is consistent with the
notion competition promotes duality. Lastly Yang makes the assumption that information costs are
cheaper when a duality CEO is present over separated leadership, because “competition increases the
28
Byron Main
value of information, especially the value of specific information” 40. To test whether specific information
is cheaper for duality CEO over separated leadership the sample from above is separated into two
groups. Firms “with above-medium values of information specificity costs and firms with below-median
values” 41 and run a base line regression analysis, the results of which are below in Table 5.
Based on the above table the following points can be concluded. Firstly duality firms with above-median
ratios of assets Tobin’s Q increases notably over that of non-duality firms of the same caliber, as
exemplified by before regression Tariff*post89*dual= 3.061 (duality) compared to Tariff*post89= -0.899
(non-duality). However both duality and non-duality firms with below media rations experience similar
albeit insignificant change.
Conclusion:
Agency theory and stewardship theory, are essentially equals and whether a company chooses
one form of corporate governance over another comes down to nothing more than which form is a
better fit for the firm based on a few main factors (industry, market environment, CEO informal power,
29
Byron Main
firm performance) therefore CEO duality had no impact at all on a firms performance. However, the
preceding turned out not to be the case, if anything the original hypothesis was nothing more than a
patchwork of conjecture, mixed with a few odd facts. The truth is CEO duality for better or worse is
imminently tied into firm performance. Throughout this paper it has been shown that CEO duality even
when not being utilized as a way of governance is still influencing, take for instance Sydney Finkelstein’s
findings of how informal CEO power, vigilant boards, CEO duality, firm performance and a whole host of
other things were all interconnected. For example if firm performance was high and CEO informal power
high, a board would not want a duality CEO for fear of entrenchment, whereas when competition is high
or firm performance is low CEO duality is sought after like a fox by a hound. Essentially whether
stewardship (CEO duality) is used by firm, is meaningless for it has already influenced their decision to
by avoiding it. In short CEO duality is the single most important factor in determining what structure of
corporate governance is chosen by a firm.
Footnotes: Could not fit into actual footnote area without compromising integrity of the entire papers structure my apologies.
30
Byron Main
1) Elsayed, Khaled. 2007. "Does CEO Duality Really Affect Corporate Performance?" Corporate Governance 15 (6): 1203-1214.Ibid. 1
2) Ibid. 12043) Ibid. 12044) Ibid. 12055) Forbes citation6) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW
BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
7) Ibid. 11008) Elsayed, Khaled. 2007. "Does CEO Duality Really Affect Corporate Performance?" Corporate
Governance 15 (6): 1203-1214.Ibid. 19) Yang, Tina and Zhao, Shan, CEO Duality and Firm Performance: Evidence from an Exogenous
Shock to the Competitive Environment (May 1, 2014). Journal of Banking and Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2177403 or http://dx.doi.org/10.2139/ssrn.2177403
10) Reference for business.com page 211) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW
BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
12) Yang, Tina and Zhao, Shan, CEO Duality and Firm Performance: Evidence from an Exogenous Shock to the Competitive Environment (May 1, 2014). Journal of Banking and Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2177403 or http://dx.doi.org/10.2139/ssrn.2177403
13) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
14) Yang, Tina and Zhao, Shan, CEO Duality and Firm Performance: Evidence from an Exogenous Shock to the Competitive Environment (May 1, 2014). Journal of Banking and Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2177403 or http://dx.doi.org/10.2139/ssrn.2177403
15) Ibid. 1116) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW
BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
17) Ibid. 108418) Ibid. 108219) Ibid. 108620) Ibid. 108621) Ibid. 108622) Ibid. 109423) Yang, Tina and Zhao, Shan, CEO Duality and Firm Performance: Evidence from an Exogenous
Shock to the Competitive Environment (May 1, 2014). Journal of Banking and Finance,
31
Byron Main
Forthcoming. Available at SSRN: http://ssrn.com/abstract=2177403 or http://dx.doi.org/10.2139/ssrn.2177403
24) Ibid. 1125) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW
BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
26) Ibid. 109627) Ibid 109628) Elsayed, Khaled. 2007. "Does CEO Duality Really Affect Corporate Performance?" Corporate
Governance 15 (6): 1203-1214.Ibid. 129) Ibid. 120630) Ibid. 120631) Ibid. 120632) Ibid. 120933) FINKELSTEIN, S., and R. A. D'AVENI. 1994. "CEO DUALITY AS a DOUBLE-EDGED SWORD: HOW
BOARDS of DIRECTORS BALANCE ENTRENCHMENT AVOIDANCE and UNITY of COMMAND." Academy of Management Journal 37 (5): 1079-1108. doi:10.2307/256667.
34) Ibid. 110135) Yang, Tina and Zhao, Shan, CEO Duality and Firm Performance: Evidence from an Exogenous
Shock to the Competitive Environment (May 1, 2014). Journal of Banking and Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2177403 or http://dx.doi.org/10.2139/ssrn.2177403
36) Ibid. 337) Ibid. 4338) Ibid. 4439) Ibid. 1840) Ibid. 18