Pilot or Watchdog? A Theory of Endogenous Choice of Advisory Role by Boards of Directors
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Citation of Original PublicationChen, D. (2005) Pilot or Watchdog? A Theory of Endogenous Choice of Advisory Role by Boards of Directors.
Abstract Corporate board is a multi-role institutional entity. In a stylized two period symmetric information model, we derive the optimal choice of advising role by directors given that every board has to perform a monitoring role. It is argued that advising the management,has cost as well as benet.,Even though advising increases the mean of the prot, board shouldn’t advise unless its prior ability exceeds CEO’s by a positive cuto,value. We prove that this cuto,value is higher under \strong owner" characterized by concentrated shareholding than \weak owner" characterized by diused,ownership structure, which suggests one potential negative eect,imposed by large shareholder setup. We also prove that instead of committing to,re the board after one period to induce their advising benet,under large shareholder setup, shareholders might just be better o to be back to diused ownership case, aside from the consideration of large shareholder extracting private benet,from the control of the corporation.