KDI FOCUS The Retention of Underperforming CEOs and the Implications on Collusion – Controlling Management and Preventing Collusion by Strengthening the Independence of the Board 2016.12.14
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- Is performance sufficiently reflected in the turnover rate of CEOs? Analysis of statistical data reveals that the probability of CEO retention in cartel firms is relatively higher than in non-cartel firms. Accordingly, this study aims to examine the CEO turnover rate in line with performance and draw upon a policy direction for implementing a socially desirable incentive mechanism. An examination into Korean firm data reveals that, in cartel firms, the probability of CEO replacement increases as the performance of the overall industry declines. On the other hand, in non-cartel firms, the probability significantly increases as the CEO’s relative performance deteriorates compared to that of rival firms. In fact, due to the low correlation rate between relative performance and CEO replacement, CEOs of cartel firms are more inclined to collude with competing firms, rather than outperform them. Then, what efforts are needed to prevent corporate collusion? To answer this question, a comparative analysis was conducted on the board of director’s supervisory capabilities in cartel firms and non-cartel firms. The results show that, compared to non-cartel firms, the proportion of outside board members with social ties to the CEO and the probability of CEO retention is much higher in cartel firms. Further still, there are almost no dissenting votes from board members in cartel firms, and instead, the probability of member replacement increases significantly if a member opposes a board agenda. Overall, it was found that the independence and supervisory capabilities of the board of directors at cartel firms is severly lacking, which inevitably creates an environment that prolongs and retains collusion. Therefore, policies to improve corporate governance are needed to strengthen board independence and to provide CEO incentives that are more in line with relative performance, this would also curb collusion. [Interview] The punishment mechanism for low performance is vital in ensuring fair competition. Of course, the implementation of a CEO incentive mechanism is wholly the firm’s decision. However, it is important to create an environment that boosts the efficiency of the incentive mechanism through policies to improve corporate governance. The CEO incentive mechanism must be based on indicators that can accurately assess CEOs’ abilities and diligence. And for these indicators to function properly, CEOs’ influence over their board of directors must be restricted in order to strengthen the board’s independence.
□ An analysis of Korean firm data reveals that there is a higher tendency for CEOs in cartel firms to maintain their posts when the overall industrial performance, and not the individuals’ relative performance, is high. This implies that an incentive for collusion, instead of competition, is created. Meanwhile, the outside directors of cartel firms have more social connections with the CEO in many cases and cast fewer opposing votes than those at competitive firms. Considering that CEO replacement is not pertinent to relative performance when a large proportion of the board of directors is close to the CEO or when there are no dissenting votes, enhancing board independence can deter the inclination to collude.
- Replacing an underperforming CEO is the basic incentive for stimulating efforts.
- Incentive mechanism for CEOs can have an impact on market competition as well as internal corporate management.
- If CEO replacement is not sensitive to relative performance, collusion is more likely than competition.
- As the performance of the overall industry, and not the CEO's relative performance, increases, the chances of CEO replacement at cartel firms declines.
- In the case of owner-family CEOs, relative performance of the CEO does not determine replacement regardless of participation in collusion.
- Underperforming CEOs have more chances of keeping their jobs in a company whose board has a high proportion of outside directors with social connections to the CEO or does not have dissenting outside directors.
- In cartel firms, the boards have a higher proportion of outside directors with social ties to the CEO, and they serve longer terms.
- Outside directors in cartel firms are less likely to oppose board agendas than those in non-cartel firms and are more likely to be replaced if he/she dissents.
- Collusion can be deterred by strengthening independence of the board and implementing proper monitoring and punishment mechanism for underperforming CEOs.
Ⅱ. Correlation between the CEO Incentive Mechanism and Collusion
Ⅲ. Policy Proposal: Call for Board Independence to Improve Corporate Governance
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