Checks and Balances in the Boardroom?
Brickley, James A., Jarrell, Gregg, Coles, Jeffrey L., Chief Executive (U.S.)
Does splitting the titles of chief executive and chairman of the board create a system of checks and balances for corporations-or confusion and dissension?
Research bears out the argument that, in the boardroom at least, one head is better than two.
Should one person hold the titles of both chief executive and chairman of the board? If you ask many observers of corporate governance, the answer is yes: Adequate discipline of top management can only occur when the two titles are held by separate individuals. Indeed, Benjamin Rosen, chairman of Compaq Computer, summarized this concern in an interview with USA Today a few years ago: "When the CEO is also the chairman, management has de facto control. Yet the board is supposed to be in charge of management. Checks and balances have been thrown to the wind."
While splitting the two titles can have potential benefits, we think there are undesirable costs to separating the titles. First, an independent chairman can indeed monitor the CEO's actions-but who then will monitor the chairman's actions? Second, separating the titles necessitates the costly and generally incomplete transfer of critical information about the firm between the CEO and the chairman. Third, withholding the title of chairman until a CEO has performed well during a probationary period gives the CEO an appropriate performance incentive. A permanent independent chairman eliminates this incentive. Fourth, splitting the titles can be confusing-both internally and externally-about who is really in charge.
Proponents of separating the titles often base their arguments on a mix of anecdotal evidence and intuitive appeal to common sense: It is, they claim, not unlike asking the CEO to grade his own homework. Among those lining up on the side for separation are the United Shareholders Association and several large public pension funds, which in recent years, have put pressure on Sears, Roebuck and other large firms to split the titles of chairman and chief executive. At the same time, legislators and regulators have pushed for separation as a matter of general board policy, including former SEC Commissioner Mary Shapiro and Rep. Edward Markey (D-MA). In 1993, Shapiro spoke favorably of the British Takeover Board's recommendation that the titles be separated to "lessen the power of the chief executive over outside directors." Rep. Markey's subcommittee held hearings in the spring of 1993 on a corporate-governance bill that considered structural board reforms such as requiring an independent chairman, establishing limits on the circumstances in which a CEO also can serve as chairman.
While empirical evidence on leadership structure is limited, some evidence appears to support the view that separating the titles would improve corporate performance. In a 1991 article published in Strategic Management Journal, P.L. Rechner and D.R. Dalton studied 141 firms that either had combined or separated the two titles between 1978 and 1983. In that sample, 21.3 percent separated the titles, while 78.7 percent had one person with both titles. Using several accountingbased performance measures, the study's authors concluded that firms with separate titles consistently outperform firms with combined titles. We disagree with the study's findings, since the authors did not control for variables that might be jointly correlated with firm performance and leadership structure.
Similarly, in a 1993 article in Journal of Banking and Finance, L. Pi and S.G. Timme examined a sample of banks from 1987 to 1990. About 25 percent of the banks had separate titles, and 75 percent had combined titles. Their results suggested that after controlling for firm size and other variables, costs are lower and return on assets are higher for firms with separate titles. This study's results, however, are limited, since the authors focused on a single, regulated industry.
Our evidence on the patterns of leadership structure in U. …