Your paper investigates the role of boards of directors in monitoring CEOs. Why do they need to monitor, don’t they trust the CEOs ?

To the extent that a CEO does not have a large equity stake in the company, that is, he might have some shares but is not one of the major owners of the firm he runs, he is not necessarily maximizing the value of the company for all the shareholders. Instead of acting in their best interest, which is what he was hired for, he might act in his own interest. This conflict of interest is part of the agency theory, and is one of the main topics of the research in corporate governance. The role of the board is therefore to monitor the CEO to make sure that he does not take actions that hurt shareholders’ interest, to make sure that he “behaves”. But this is not the board’s only role. Another function of the board, not a very well documented one, is to assess the competence of the CEO. If the CEO behaves but is not competent, shareholders are not better off… While the corporate governance literature emphasized the conflict of interest, it somehow ignores this essential question: is the CEO good enough?

But why would they have hired him in first place, if he was not good enough?

First, because competence is relative to a particular situation: a CEO may be excellent at running a start-up, but as the firm grows, thank to his job, he may not be able to manage it as well as he used to. Or if the firm faces a particular economic situation which requires some specific abilities, replacing the CEO might be the best option. We could illustrate this with a firm facing financial constraint during an economic crisis: if the best thing to do is to reduce the costs, then it may be best to appoint a “cost cutting manager”. So the role of the board is not only to make sure the CEO does the right things, but also that he is still the right person to do the job. Second, there is always uncertainty about someone’s competence. When board members appoint a CEO, they believe him to be competent but in the same time they know, or at least they should know, that they might be wrong about him. As time goes on and as the CEO manages the company, the board should monitor him in order to update their beliefs about his ability. And they may end up realizing they were wrong in the first place, when they took the decision to hire him. This gives the board a dual role: make sure the CEO behaves, and make sure is the right person for the job. And what our paper show is that this aspect of the board purpose is in fact a major concern for directors, and that they indeed spend part of their time trying to find out whether the CEO is good at running the company or not.

How do you show this?

Our paper is empirical, so we take a sample of firms, study the board actions and see the relations between firm performance, board monitoring and CEO turnover, using statistical tests. There is a very large theoretical literature that states that monitoring matters but few studies investigate what boards really do. Thanks to the European Bank for Reconstruction and Development (EBRD) we were able to build database for a large sample of firms, almost 500, and on an 18-year period, with two very important points. First, these firms we study all have a large shareholder – private equity funds working with the EBRD – which matters because for a small shareholder the cost of monitoring – in terms of time or money – exceeds its benefit while a blockholder has a clear interest in monitoring. Second, these firms are located in the former socialist countries of Central Eastern Europe. This is extremely interesting because there was a law change in the 90’s that allows the boards to dismiss a CEO without having to ask for the permission of the shareholder, which was not the case before the law was passed. So we can compare the situation before the law change with the situation afterwards and see what it implies. And we show that this strengthen of board power is a good thing, because it allows the board to dismiss an incompetent CEO.

The possibility for a board to fire the CEO without the shareholders’ consent is a good thing for shareholders then?

Indeed, if the decision is made on the basis of information obtained by the board through monitoring. This is where we should distinguish between soft and hard information. Basically, hard information is about numbers: the accounting and financial reports of the firm. Research in corporate governance focuses too much on hard information, stating that boards rely on it when deciding to dismiss or not a CEO. But why would you even need a board then? The shareholders could just look at the numbers themselves because this is public information, and they could take the decision themselves without having to pay the wages of the board members. So the interest of having a board lies also, maybe more, in acquiring soft information through monitoring. This allows the members of the board to find out whether the CEO takes the good decisions or not and whether he is competent or not. And what comes out of our study is that the role of the board goes indeed further than looking at the numbers. And this is essential because numbers can lie: because there is always uncertainty in the consequences of a decision, a good decision may lead to bad performance. In other word the CEO may have been unlucky. The opposite can happen too. Another problem is that numbers only give information on what has happened so far, and not on what is likely to happen. We could once again use the example of a growing company: such a company would have good numbers but what matters is what is next, and the board’s decision to dismiss or keep a CEO does not rely only on the firm prior performance but on what they think the future performance will be with or without the current CEO. For researchers taking this into account is extremely important, otherwise you would face an endogeneity problem: if you only look at the numbers, boards that fire a CEO before the situation deteriorates would appear as bad boards that dismiss good CEOs to hire bad ones, while they are in fact anticipating! This is a very common error in finance, in this topic particularly. This is why using soft information, which is what the board members think, their opinions as they report them, matters a lot.

And what do you find?

We find that boards do monitor CEO, that they collect both hard and soft information about the CEO performance and competence and that they take the decision to fire the CEO based on these two types of information. A CEO may be dismissed if his results are not good enough or if the board considers that he is not qualified enough for the job. We also show that board can tell the difference between bad luck – such as unfavorable economic situation – or honest mistake – a bad decision of the CEO but one he took thinking it would benefit shareholder – and misbehavior or incompetency. And we show that this improves the overall performance of a firm. Using the law change we compare the situation when soft information could hardly be a sufficient basis to act against a CEO with the situation when boards don’t need to have the shareholders approval to take decisions. We show that the possibility for the boards to fire CEOs they believe to be incompetent improves the mean performance a lot. This suggests that giving more power to boards is a good thing for the shareholders.

Pr. Francesca Cornelli (London Business School)

Francesca Cornelli, Head of the Finance Department at London Business School and associate editor of the prestigious Journal of Finance is truly one the most influential academics in Finance. She is a Research Fellow of the Center for Economic and Policy Research (CEPR) and a member of the Scientific Committee of the Banque de France Foundation. With co-authors Zbigniew Kominek and Alexander Ljungqvist they have studied the role of the Board of Directors and the impact of monitoring on CEOs turnover. They have showed the importance of « soft information » in the board decision to dismiss the CEO.


Corporate Finance, Industrial Organization, Mechanism Design, Transition Economics 


London Business School (LBS)  / Journal of Finance (Associate Editor)  / Review of Economic Studies (Editorial Board)  / Institute of Finance and Accounting 


Monitoring Managers: Does it Matter? F. Cornelli, Z. Kominek et A. Ljungqvist. Journal of Finance, Volume 68, Issue 2, pages 431–481, April 2013. Available here!


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