Academic journal article Entrepreneurship: Theory and Practice

CEO Stakes and Board Composition in Small Private Firms

Academic journal article Entrepreneurship: Theory and Practice

CEO Stakes and Board Composition in Small Private Firms

Article excerpt

CEOs of small firms must reconcile two countervailing interests with respect to their board composition choices. Boards with substantial representation by "independent" directors--individuals who are not linked to the CEO via personal or professional relationships--may be more effective in providing good counsel and linkages to external resources, but may also limit CEO discretion. This study investigates whether CEO ownership, family, and generational "stakes" in the business--indicators of CEO desire to protect discretion from board interference--are related to board composition. The results (survey of 2365 small private firms) indicate that CEOs with greater ownership and family stakes have less independent board compositions.

The board of directors performs a number of functions for the large publicly traded corporation, including advising and counseling top management, representing the firm to external constituents, and providing access to external resources (Lorsch & MacIver, 1989; Zahra & Pearce, 1989). The board's most fundamental responsibility, however, is to ensure that top management's actions are consistent with the interests of the firm's shareholders (Fama & Jensen, 1983). Although CEOs undoubtedly value the good counsel, representation, and resources that effective boards provide, they may not necessarily welcome board vigilance on behalf of shareholders. After all, CEO interests sometimes conflict with shareholder interests, and boards cannot be effective guardians of shareholder wealth unless they have the power to limit CEO pursuit of self-interests at shareholders' expense (Fama & Jensen, 1983). On the other hand, powerful CEOs are apt to be more involved in the selection of directors, and so they have the potentia l to configure boards that are less inclined to threaten their discretion (Finkelstein & Hambrick, 1996). Consequently, assuming the CEO has sufficient power to influence the director selection process, the composition [1] of a large firm's board should reflect the level of the CEO's interest in preserving discretion. Although CEO power is central to agency theoretic explanations of the determinants of board composition (Finkelstein & Hambrick, 1996), CEO self-interest and desire for discretion is taken for granted in this literature (Zahra & Pearce, 1989).

Small firm CEOs tend to have more power to effect organizational outcomes than large firm CEOs (Eisenhardt & Schoonhoven, 1990), and this power can manifest in their board composition choices (Castaldi & Wortman, 1984; Mintzberg, 1983). Indeed, CEOs of small private firms often have even more power over the selection and retention of directors by virtue of their typically high level of ownership (Mace, 1971). Because these CEOs have greater capacity to institutionalize their interests, we suspect that the relationship between CEO desire for discretion and board composition will be stronger, and thus more easily observable, in a sample of small private firms, In this paper, we examine whether the CEO' s "stakes" in the firm--which serve as indicators of the desire to protect discretion--are related to board composition. In particular, we explore whether CEOs with greater stakes tend to compose boards that are less threatening to CEO discretion.

In addressing this issue our research makes four contributions to the larger literature on boards of directors. First, most empirical studies of corporate governance have gathered their data from large publicly traded corporations, and the results may not apply to small private firms (Daily & Dalton, 1992b, 1993). Our research represents a large-scale empirical study of governance in small private firms, an important but under-researched sector of the U.S. economy (Ward & Handy, 1988). Second, many large public corporations began as small private firms, and so the boards of these large firms somehow evolved from the boards of small firms. …

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