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INFLUENCINGONBOARDS By GEORGEDRYMIOTES ADISSERTATIONPRESENTEDTOTHEGRADUATESCHOOL OFTHEUNIVERSITYOFFLORIDAINPARTIALFULFILLMENT OFTHEREQUIREMENTSFORTHEDEGREEOF DOCTOROFPHILOSOPHY UNIVERSITYOFFLORIDA 2004 Copyright2004 hy GeorgeDrymiotes ToLiana. ACKNOWLEDGMENTS Iamdeeplyindebtedtomyadvisor,JoelS.Demski,forhispatience; support;andmostimportant,forshowingmetheroadtoacademicinquiry. Ialso wishtothankProfessorsFroysteinGjesdal,KarlE.Hackenbrack,BipinB.Ajinkya andChunrongAifortheirhelpfulcommentsandsuggestions. Finally,Igratefully acknowledgefinancialsupportfromtheDeloitteFoundation. IV TABLEOFCONTENTS ACKNOWLEDGMENTS iv LISTOFTABLES vii LISTOFFIGURES viii ABSTRACT ix CHAPTER 1 INTRODUCTION 1 Prologue 1 MotivationandContribution 4 2 LITERATUREREVIEW 6 Introduction 6 InfluencingEvidence 6 EmpiricalStudies 10 PerformanceandBoardCharacteristics 11 BoardActionsandCharacteristics 13 BoardCharacteristics 17 TheoreticalStudies 19 Critique 20 Conclusions 23 3 MODELSETUPANDBENCHMARK 24 Introduction 24 TimeLine 24 ThePlayers 24 Benchmark 28 Conclusions 31 4 COSTLESSINFLUENCING 33 Introduction 33 InfluencingAnalysis 34 ConditionalInfluencingCase 34 UnconditionalInfluencingCase 37 V FocusonNegativeInfluencing 40 GeneralDiscussiononInfluencing 42 Social-Welfare 45 Conclusions 46 5 COSTLYINFLUENCING 48 Introduction 48 ModelModifications 49 InfluencingAnalysis 49 ConditionalInfluencingCase 49 UnconditionalInfluencingCase 54 ShareholdersandBoDControlCostofInfluencing 56 Conclusions 57 6 PRODUCTIVITYCOSTOFINFLUENCING 59 Introduction 59 ModelModifications 59 InfluencingAnalysis 61 Conclusions 66 7 CONCLUSIONS 67 APPENDIX 73 A PROOFSFORCHAPTER3 73 B PROOFSFORCHAPTER4 75 C PROOFSFORCHAPTER5 80 D PROOFSFORCHAPTER6 83 LISTOFREFERENCES 84 BIOGRAPHICALSKETCH 89 VI 3- LISTOFTABLES Table page 4- 1 Monitoringandinfluencingeffectsonmonitoringsignal 27 3 2 Summaryofparametervalues 32 4- 3 3 Benchmarknumericalexample 32 5-1 Conditionalinfluencingnumericalexample 37 4 2 Unconditionalinfluencingnumericalexample 40 46--3 "Limited"influencingnumericalexample 42 4 Generalinfluencingnumericalexample 45 b-1 Personallycostlyconditionalinfluencingnumericalexample 54 2 Personallycostlyunconditionalinfluencingnumericalexample .... 56 6 1 Influencingimpactonproductivity 60 6^2 Additionalparametervaluesfornumericalexamples 64 3 No-influencingandconditionalinfluencingnumericalexample 64 6-4 Conditionalinfluencingwithproductivitycostnumericalexample... 66 vii 3- LISTOFFIGURES 4- Figiire page 3 1 Generaltimeline 25 2 Benchmarkcasetimeline 30 1 Conditional-influencingcasetimeline 35 viii AbstractofDissertationPresentedtotheGraduateSchool oftheUniversityofFloridainPartialFulfillmentofthe RequirementsfortheDegreeofDoctorofPhilosophy INFLUENCINGONBOARDS By GeorgeDrymiotes August2004 Chair: JoelS.Demski MajorDepartment: FisherSchoolofAccounting Wedevelopedatheoryoninfluencingbetweentheboardofdirectors andmanagement,usinganagencymodeltorepresenttherelationshipbetween acorporation’sboardandmanagement. Managementhastheoptiontoaffect howdirectorsinterpretinformationrelatedtoitsperformance;itcanpotentially makedirectorsinterpretinformationmoreinfavorofmanagement,givingitmore creditforgoodnewsandlessblameforbadnews. Thisparticularaspectofthe interactionbetweentheboardandmanagementisthefocusofourstudy. We viewtheboardasacorporate-governancemechanism,whoseroleistomonitor andcompensatemanagement;andanalyzehowinfluencingaffectsitsbehavior, withemphasisonitseffectivenessasacorporate-governancemechanism. Standard intuitionsuggestsinfluencingisdetrimentaltotheboardandshareholders. However,ouranalysisshowsthatinfluencing,dependingonitscharacteristics,can beefficient. Itcanbeusedasapartialsubstituteformonitoringandcanreduce themanager’sriskexposure. Furthermore,incaseswherethemanagercanuse influencingtofacilitateshirking,theboardpreemptivelyincreasesmonitoring; thiscanresultinsocial-welfaregains. Ouranalysisincludescaseswithcostless IX influencing,caseswhereinfluencingispersonallycostlyforthemanager,andcases whereinfluencingimpactsthemanager’sproductivity. Forcostlessinfluencing,the boardcannotpreventthemanagerfrominfluencing. However,wheninfluencingis personallycostlyforthemanager,theboardcanpreventinfluencingbyincreasing itsmonitoringintensity;thiscanalsoleadtosocial-welfaregains. Finally,we analyzeacasewithmultiplesourcesofinformation,someofwhicharenotsubject toinfluencing,anddiscusstheboard’sandmanagement’sbehavior. Overall, influencingcanbeefficient,andtheboardcanbeaneffectivecorporate-governance mechanism,despiteinfluencing. X