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    Board Monitoring and Endogenous Information Asymmetry.
    research summary posted July 29, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.09 CEO Tenure and Experience, 14.10 CEO Compensation 
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    Title:
    Board Monitoring and Endogenous Information Asymmetry.
    Practical Implications:

    The author claims that motivating the CEO to reveal information may or may not be beneficial. The disconnection between compensation and outcomes results from active monitoring. Compensation contracts rely on board evaluation, not on the final outcomes, to provide incentives. The proactive board activity can result in poor firm performance. This proactive activity requires extra care to reign in an expert: the CEO.

    Citation:

    Tian, J. J. 2014. Board Monitoring and Endogenous Information Asymmetry. Contemporary Accounting Research 31 (1): 136-151.

    Keywords:
    boarding monitoring, information acquisition, information asymmetry, project decision, executive compensation, CEO compensation
    Purpose of the Study:

    Boards of directors are frequently questioned pertaining to their monitoring role in executive decision making and compensation. The sequence of financial fraud in the early 2000s called public attention that boards have not done enough to align executive incentives with shareholders’ interests. Since shareholders do not normally observe executives’ actions and may not even know what actions executives should have taken to maximize shareholder value, increasing board effort to reduce such information asymmetry is commonly viewed as desirable.

    The present study challenges this common view that increasing board effort in monitoring is always desirable. This view neglects a key fact in corporate decision making: the information asymmetry between the CEO and shareholders is a result of the CEOs expertise. This study highlights the fact that CEOs are hired for their superior ability to make strategic decisions, particularly for their unique skills to acquire, process and interpret information relevant to these decisions.

    Design/Method/ Approach:

    The authors uses analytical modeling to conclude on the questions of interest.

    Findings:

    If board monitoring eliminates all information asymmetry, the board can easily ensure that decisions are made in the best interest of shareholders. It resolves all uncertainty in the remaining decision problems. However, preserving uncertainty is crucial ex ante in order to motivate a risk-averse CEO to acquire information, as effort need not be expended if there is no concern for uncertainty. Thus, board monitoring creates a time consistency problem for the CEO to acquire information.

    The board should actively engage in monitoring activities only when the board is able to evaluate the information provided by the CEO with high accuracy. That is, when board monitoring is able to produce enough information about the CEO’s effort directly, preserving uncertainty to incentivize the CEO to acquire information is a second-order concern. However, if a project requires special skills for implementation and board evaluation may not be accurate enough, it is better for the board to remain passive and not interfere with the CEO’s decisions.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Board/Audit Committee Oversight, CEO Compensation, CEO Tenure & Experience