Firms’ Rationales for CEO Duality: Evidence from a Mandatory Disclosure Regulation

The common practice of combining the roles of the CEO and chairman of the board (CEO duality) has been the topic of one of the longest debates in corporate governance. On the one side, a majority of S&P 500 firms combine the two roles. On the other side, investors and governance experts—via shareholder proposals and public campaigns—frequently pressure firms into separating the two roles, emphasizing a lack of effective managerial oversight under CEO duality. Nevertheless, most such proposals do not receive majority support, which suggests disagreement among shareholders about the value of CEO duality. Such disagreement is consistent with the inconclusive academic literature on the relation between CEO duality and firm performance (for a review, see Krause, Semadeni, and Cannella, 2014), as well as the lack of reliability of extant studies likely suffering from the non-random choice of board structures. The above discussion highlights the need for both practitioners and scholars to better understand why firms combine or separate the CEO and chairman roles.

Against this background, our paper entitled Firms’ Rationales for CEO Duality: Evidence from a Mandatory Disclosure Regulation exploits a 2009 amendment to Regulation S-K, which requires public firms to disclose the reasons for combining or separating the roles of CEO and chairman. We provide unique evidence on the first-time disclosure by S&P 500 companies of the reasons behind their board leadership structure. Thereby, we propose a novel approach to understanding why firms have opted for or against CEO duality. Examining the stock market reaction to firms’ disclosures, we also assess the value implications and informativeness of the stated reasons.

Concerning the choice of CEO duality and its value implications, competing theories predict that combining the two roles has either net costs or net benefits. Agency theory suggests that CEO duality increases the CEO’s power over the board, which leads to higher agency costs (such as greater consumption of perquisites), particularly for larger and more complex firms that are more difficult to monitor and have more resources to waste (e.g., Jensen and Meckling, 1976). However, according to the theories of resource dependence (e.g., Pfeffer, 1972) and stewardship (e.g., Donaldson, 1990), CEOs act in the interest of shareholders by making use of the stronger and unified leadership that comes with duality. Unified leadership mitigates coordination and information acquisition costs and facilitates effective decision making and adaptability, which is crucial for firms operating in competitive and dynamic environments. Further, Adams and Ferreira’s (2007) model predicts that powerful CEOs are willing to share more information with other directors on the board under unified leadership, which can be particularly beneficial for opaque firms.

We find that the main reasons firms state for leadership structure are consistent with the aforementioned theories. Based on the proxy statements filed with the Securities and Exchange Commission (SEC) over the one-year period (“the proxy season”) after the amendment to Regulation S-K became effective, our study identifies 24 (22) distinct reasons for combining (separating) the two roles. Regarding the justifications for combining of the two roles, 56% of the firms cite “Unified leadership”, arguing that having a CEO-chairman promotes clear and consistent leadership, directional clarity, and effective decision making. Forty-six percent state that combining the two roles allows them to lever the CEO’s in-depth knowledge of the firm and its operations, while 23% state that it enables the CEO to act as a bridge between management and the board, thereby promoting information flows between the two. These reasons highlight the importance of effective decision making and asymmetric information when justifying CEO duality, supporting organization theories and the theory of friendly boards by Adams and Ferreira (2007). Turning to non-duality firms, the main reasons such firms state for separating the CEO and chairman roles are based on the importance of agency costs, consistent with agency theory. Specifically, 33% of such firms report that they separate the two roles to account for the inherent differences between the tasks and roles of the CEO and chairman, and another 30% state that having a separate chairman facilitates managerial oversight.

Regarding the differences as to how firms state their reasons for combining (separating) the CEO and chairman roles, our study finds that firms with CEO duality report significantly more distinct reasons (2.1 vs. 1.7) and use more words as well as more positive and negative words. These patterns indicate that firms are aware of the controversy surrounding CEO duality and, hence, cater to investors’ needs for more information regarding the firm-specific reasons for having duality. Further, we carry out several tests, which mitigate the concern that firms do not report the true reasons for their choice of board leadership structure. For example, we find that firms’ sections on board leadership show a low textual similarity (13% on average), implying great individuality across firms. We also find that firms revise their sections on board leadership structure when they change their CEO.

Finally, our study addresses the question whether investors consider the reasons for combining (separating) the CEO and chairman roles to be informative, and if so how they assess them. To this end, we study the stock market reaction to firms’ first-time disclosure of the most frequently stated reasons. Our results imply that the reasons differ with respect to their informativeness for investors and that CEO duality has implications for shareholder value. Specifically, while the stock market reaction to the disclosure of most reasons is statistically insignificant, the stock market reaction to the most important reason for CEO duality, i.e., “Unified leadership”, becomes significant once the characteristics of the firm are taken into account. That is, the market reaction is significantly negative for large and complex firms, which have more resources to waste and are more difficult to monitor. On the contrary, it is significantly positive for small and less complex firms and for firms in more competitive and dynamic environments. For these firms, having unified leadership via a combined CEO-chairman—who can make decisions more effectively and enhance the firm’s adaptability—is likely more valuable, whereas monitoring is less valuable. Our study finds little evidence of a significant market reaction to the disclosure of the reasons for the less contentious choice of separating the CEO and chairman roles. This result is in line with less need from investors to obtain information about why firms separate the two roles.

Overall, our study improves our understanding of CEO duality in several ways. First and most importantly, while existing studies have typically been unable to identify the reasons underlying the selection process of the leadership structure of the board, this study is the first to present evidence on the reasons that firms state for their board leadership structure. Second, the results of the study also indicate that the stock market considers a “one-size-fits-all” approach to CEO duality inappropriate. Finally, the evidence suggests that the SEC disclosure reform we study is informative for investors as the reasons firms state for their board leadership structure help investors assess the appropriateness of that structure.

The complete paper is available for download here.