Benjamin E. Hermalin

The Determinants of Board Composition

We identify factors that lead to changes among corporate directors. We hypothesize that the CEO succession process and firm performance will affect board composition. Our findings are consistent with both hypotheses. When their CEO nears retirement, firms tend to add inside directors (who may be possible candidates to be the next CEO) Just after a CEO change, inside directors with short tenures appear more likely to leave the board (they, perhaps, being the losing candidates). We also find that inside directors are more likely to leave the board and outside directors more likely to join after a firm performs poorly and when a firm leaves a product market.

Toward an Economic Theory of Leadership: Leading by Example

This paper explores leadership within organizations. Leadership is distinct from authority because following a leader is a voluntary rather than coerced activity of the followers. This paper considers how a leader induces rational followers to follow her in situations when the leader has incentives to mislead her followers.

The Effects of Competition on Executive Behavior

Economists presume that competition spurs a firm to be more efficient by forcing it to reduce its agency problems. This article investigates this presumption. It finds that the effects of competition on executive behavior can be decomposed into four effects, each of which is of potentially ambiguous sign. Theory thus offers no definitive defense of this presumption. This article also derives sets of conditions under which increased competition has the presumed effect of reducing agency problems. In some sets, important conditions are that increased competition reduce the executives expected income and that agency goods (e.g., shirking) be normal goods for the executive. The article shows that an increase in the shareholder bargaining strength can both reduce the agency problem and make it more sensitive to competition.

Governance, performance objectives and organizational form: evidence from hospitals

Abstract In a sample of California hospitals, we find that the composition of the board of directors varies systematically across ownership types. For all ownership types, except government-owned, we find that poor financial performance is related to board and CEO turnover. However, different ownership types place different weights on levels of charity care and administrative expenses. Our overall findings support the proposition that ownership type reflects heterogeneity across consumers and producers, and that differences in these groups lead to differences in the organizations objectives and governance.

The Economics of Network Neutrality

Pricing of Internet access has been characterized by two properties. Parties are directly billed only by the Internet Service Provider (ISP) through which they connect to the Internet and the ISP charges them on the basis of the amount of information transmitted rather than its content. These properties define a regime known as “network neutrality.” In 2005, some large ISPs proposed that application and content providers directly pay them additional fees for accessing the ISPs’ residential clients, as well as differential fees for prioritizing certain content. We analyze the private and social incentives to introduce such fees when the network is congested and more traffic implies delays. We find that network neutrality is welfare superior to bandwidth subdivision (granting or selling priority service). We also consider the welfare properties of the various regimes that have been proposed as alternatives to network neutrality. In particular, we show that the benefit of a zero-price “slow lane” is a function of the bandwidth the regulator mandates be allocated it. Extending the analysis to consider ISPs’ incentives to invest in more bandwidth, we show that, under general conditions, their incentives are greatest when they can price discriminate; this investment incentive offsets to some degree the allocative distortion created by the introduction of price discrimination. A priori, it is ambiguous whether the offset is sufficient to justify departing from network neutrality.

Contract Renegotiation and Options in Agency Problems

This article discusses the ability of an agent and a principal to achieve the first-best outcome when the agent invests in an asset that has greater value if owned by the principal than by the agent. When contracts can be renegotiated, a well-known danger is that the principal can hold up the agent, undermining the agents investment incentives. We begin by identifying a countervailing effect: Investment by the agent can increase his value for the asset, thus improving his bargaining position in renegotiation. We show that option contracts will achieve the first best whenever his threat-point effect dominates the holdup effect. Otherwise, achieving the first best is difficult and, in many cases, impossible. Copyright 2000 by Oxford University Press.

Sender or receiver: who should pay to exchange an electronic message?

We examine the pricing implications of call externalities, the benefits enjoyed by the recipient of a message sent by another user. We show that, with or without a network-profitability constraint, efficient pricing requires consideration of demands, as well as costs. We present conditions under which equal charges for sending and receiving calls maximize welfare and profits. We also present conditions under which the receiving partys subsidizing the sender maximizes welfare and profits. Last, we show that menus of pricing options can increase welfare and profits. None of these findings holds in the absence of call externalities.

Transparency and Corporate Governance

An objective of many proposed corporate governance reforms is increased transparency. This goal has been relatively uncontroversial, as most observers believe increased transparency to be unambiguously good. We argue that, from a corporate governance perspective, there are likely to be both costs and benefits to increased transparency, leading to an optimum level beyond which increasing transparency lowers profits. This result holds even when there is no direct cost of increasing transparency and no issue of revealing information to regulators or product-market rivals. We show that reforms that seek to increase transparency can reduce firm profits, raise executive compensation, and inefficiently increase the rate of CEO turnover. We further consider the possibility that executives will take actions to distort information. We show that executives could have incentives, due to career concerns, to increase transparency and that increases in penalties for distorting information can be profit reducing.

The Effect of Affect on Economic and Strategic Decision Making

The standard economic model of decision making assumes a decision maker makes her choices to maximize her utility or happiness. Her current emotional state is not explicitly considered. Yet there is a large psychological literature that shows that current emotional state, in particular positive affect, has a significant effect on decision making. This paper offers a way to incorporate this insight from psychology into economic modeling. Moreover, this paper shows that this simple insight can parsimoniously explain a wide variety of behaviors.

A Framework for Assessing Corporate Governance Reform

In light of recent corporate scandals, numerous proposals have been introduced for reforming corporate governance. This paper provides a theoretical framework through which to evaluate these reforms. Unlike various ad hoc arguments, this framework recognizes that governance structures arise endogenously in response to the constrained optimization problems faced by the relevant parties. Contract theory provides a set of necessary conditions under which governance reform can be welfare-improving: 1) There is asymmetric information at the time of contracting; or 2) Governance failures impose externalities on third parties; or 3) The state has access to remedies or punishments that are not available to third parties. We provide a series of models that illustrate the importance of these conditions and what can go wrong if they are not met.