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The Retention of Underperforming CEOs and the Implications on Collusion – Controlling Management and Preventing Collusion by Strengthening the Independence of the Board

Hwaryung Lee

No 77, KDI Focus from Korea Development Institute (KDI)

Abstract: 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.

Date: 2016
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