Who Chooses Board Members?

We exploit a recent regulation passed by the US Securities and Exchange Commission (SEC) to explore the nomination of board members to US publicly traded firms. In particular, we focus on firms’ use of executive search firms versus allowing internal members (often simply the CEO) to nominate new directors to serve on the board of directors. We show that companies that use search firms to find board members pay their CEOs significantly higher salaries and significantly higher total compensations. Further, companies with search firm-identified directors are significantly less likely to fire their CEOs following negative performance. In addition, we find that companies with search firm-identified directors are significantly more likely to engage in mergers and acquisitions and to see abnormally low returns from this M&A activity (CEO compensation and monitoring along with acquisition strategy being perhaps the most attributable to board decision-making). We then instrument the endogenous choice of using an executive search firm when choosing directors through the varying geographic distance of companies to executive search firms. Using this instrumental variable framework, we show search firm-identified directors’ negative impact on firm performance, consistent with firm behavior and governance consequences we also document.