By Patricia Q. Connolly, Executive Director of the Drexel University LeBow College of Business Center for Corporate Governance
Is splitting the role of chairman and CEO in the best interest of the company? Although the question is hardly new, it continues to be a topic of interest for directors and key stakeholders.
Boards are feeling increasing pressure on two major fronts – both from regulators and activist shareholders who favour separation of the roles.
In 2010, the SEC under Dodd-Frank adopted rules that required companies to disclose in their proxy statements why its board chairman and CEO positions are unified or separated. Since 2005, the S&P 500 Index has received more than 300 proxy proposals from shareholder activists, institutional investors and proxy advisory firms requiring the separation of the two roles.¹ Are these stakeholders correct? Let’s explore the facts.
Outside of the United States, having separate chair and CEO roles is much more common. For example, 76 per cent of companies in the FTSE 100 (UK), 50 per cent of companies in the DAX (German) and 55 per cent of companies in the TSE 60 (Canada) had independent board chairs.² In the S&P 500 Index (US), 48 per cent of companies have split the chair/CEO role, which is a 19 per cent increase since 2005. Although there has been momentum in US corporations toward separate roles, one may wonder why there has been reluctance to embrace the concept as quickly as their UK counterparts. For one, the unified role has history and sentiment on its side. Corporations with a joint chair and CEO have been operating effectively for years.
“When a board’s chairman is also the CEO, that individual is tasked with driving the operational goals of the firm while monitoring his or her self”
Those in favour of a unified role argue that no clear theoretical or empirical evidence exists linking a separate role to increased corporate performance. One research study found no statistical relationship between the independence status of the chairman and operating performance.³ A second study did not find evidence to support a change in independence (separate or unified) has any impact on future operating performance.4 Furthermore, additional research found companies that split roles as a result of investor pressure have negative returns around the announcement date and lower operating performance.5
Supporters continue to argue that a unified chair/CEO role ensures strong central leadership and oversight. Even when faced with declining sales and a $6billion trading loss in 2012, the shareholders of JPMorgan Chase voted to preserve Jamie Dimon’s role of chairman and CEO because they believed in his leadership during a time of financial
and economic uncertainty. Analysts in favour of Dimon’s dual role voiced concerns over declining sales at other corporations directly following separation of the role, which resonated with JPMorgan Chase’s shareholders, despite the lack of scholarly evidence supporting those claims.
Those in opposition of a unified role argue that a combined chair/CEO allows for the corporation’s decision making process to lie in his or her hands with minimal checks and balances. They believe that having a separate chair increases the board’s independence from the management team, which leads to greater oversight. However, the opposition questions the validity that the split of the chair/CEO role actually creates independent leadership. A 2009 study examined directors considered independent by NYSE standards and those who are socially independent in relation to the CEO. The research found board members who shared social connections to the CEO, but were considered independent by NYSE standards, were likely to pay the CEO more and less likely to fire a CEO following poor operating performance.6
Despite there being no clear evidence that a separated or unified role directly links to increased operating performance, research does lend support to those in favour of the separation of the chair/CEO role in the area of executive compensation. Research conducted in 2012 by the Harvard Law School Forum on corporate governance and financial regulation found that executives in a combined CEO/chair role earned a median of $16million annually; whereas, a CEO plus a separate, independent chairman earned a median of $9.3million combined. It is the board’s responsibility to vote on executive compensation packages, so when the CEO is also the chairman, he or she is voting on their own compensation package. In addition to this conflict of interest, issues involving board dynamics may arise. Directors may find it difficult to vote for smaller compensation increases with the chair/CEO a part of the decision making process.
In addition to greater executive compensation packages, studies show that corporations with a combined chair/CEO role present greater risk for investors and provide lower stock returns in the long run. Five-year shareholders see returns 28 per cent higher at companies with separated roles than at those with a unified role. Additionally, research has found the corporations with a combined role present greater accounting and ESG risk than those with the separated roles. Due to the separation costing less, presenting less risk and being a better investment, those in favour believe these practical considerations make the case for separate chair/CEO roles.
The role of the board is to provide strategic oversight and to ensure the corporation is operating in the best interest of the shareholders. When a board’s chairman is also the CEO, that individual is tasked with driving the operational goals of the firm while monitoring his or her self. This calls into question if a joint role is good corporate governance. It is believed that a board led by an independent chairman is more likely to better identify areas of improvement within the company that stray from the strategic vision. It is difficult to expect a single individual to be immersed in the operational details of company all the while self-governing.
It is unfortunate that I end this on a cliché, but clichés exist for a reason. One size does not fit all. I expect this discussion to be ongoing among directors as boardrooms continue to engage in leading practices. There is no doubt that this topic will remain one of intrigue to investors, regulators and researchers. I personally look forward to continuing the dialogue.
About the Author:
Patricia Q. Connolly is an executive with notable success guiding discussions on how to lead and govern in the 21st century. While supporting and contributing to multiple boards of directors, she has brought energy and transparency to the task of corporate governance
1Larcker, David F. and Tayan, Brian, Seven Myths of Boards of Directors (September 30, 2015). Rock Center for Corporate Governance at Stanford University Closer Look Series: Topics, Issues and Controversies in Corporate Governance No. CGRP-51
2Board Leadership: The Split CEO/Chairman Structure Debate. – Deloitte CFO – WSJ. Deloitte, 29 June 2012. Web. 07 July 2016.
3Boyd, B. K. (1995), CEO duality and firm performance: A contingency model. Strat. Mgmt. J., 16: 301–312.
4Baliga, B. R., Moyer, R. C. And Rao, R. S. (1996), Ceo Duality And Firm Performance: What’s The Fuss?. Strat. Mgmt. J., 17: 41–53.
5Dey, Aiyesha and Engel, Ellen and Liu, Xiaohui, CEO and Board Chair Roles: To Split or Not to Split (16 December, 2009). Chicago Booth Research Paper No. 09-23.
6Hwang, Byoung-Hyoun and Kim, Seoyoung, It Pays to Have Friends (August 1, 2008). Journal of Financial Economics (JFE), Forthcoming.