IMPACT OF INTERNAL GOVERNANCE ON A CEO’S INVESTMENT CYCLE

Abstract

Agency theory tells us that unless CEO owns 100% of the firm, the motive of CEO will deviate from maximizing shareholder’s wealth. Furthermore, we would expect that conflict of interest between CEO and shareholders escalates as the CEO grows older and closes to retirement because the CEO horizon is much shorter than the shareholder. To mitigate the agency problem and the horizon issue, the literature suggests and examines various forms of corporate governance provisions such as compensation package design, board governance and external regulations. In this paper, we focus on the impact of internal governance, the monitoring of the CEO from within the top management, upon the investment policy of the firm around the CEO turnover period. Previous literature has found that there is a substantial change in the firm’s investment policy around the turnover event. The mechanism of internal governance is conceptualized in Acharya, Myers and Rajan (2011), and we modify the empirical proxy in Aggarwal, Fu and Pan (2017) whereby using the text mining technique, REGEX in R and Python. We demonstrate that the change in investment policy for myopic old CEO is less likely to occur during the transition period if the firm prior to the CEO turnover event had effective internal governance. Moreover, the empirical evidence implies that the asset disposal that happens at the beginning of a CEO’s tenure is more likely due to skill set mismatch. We further find that good governance helps incoming CEOs get rid of less profitable investments previously made by older and myopic predecessors at less loss or perhaps even a gain. _____________________________________________________________________________________ a Rutgers Business School, and b Columbia Law School, respectively. Corresponding author: Ivan Brick; [email protected]