Is an Outside Chair Always Better? The Role of Non‐CEO Inside Chairs on Corporate Boards

• Published date: 01 November 2015
• Date: 01 November 2015
• Author: Shawn Mobbs
• DOI: http://doi.org/10.1111/fire.12077

The Financial Review 50 (2015) 547–574

Is an Outside Chair Always Better? The

Role of Non-CEO Inside Chairs

on Corporate Boards

Shawn Mobbs

University of Alabama

Abstract

Proponents of separating the CEO and chairman positions advocate having an outside

chairperson, although having an inside chairperson can be valuable for some firms. I find

inside chairs are more likely where firm-specific human capital is more important and, in these

firms, inside chairs are associated with higher firm valuationand better operating performance.

Furthermore, skilled inside chairs increase forced CEO turnover sensitivity to performance.

The evidence suggests that certain inside chairs can be valuablewhen firm-specific information

is important for monitoring and an outside chair may be costly.

Keywords: board of directors, CEO turnover, inside chair, CEO succession, CEO duality

JEL Classifications: G30, G34

1. Introduction

For years, corporate governance proponents have encouraged firms to separate

the roles of the CEO and the chairman of the board (Jensen, 1993). The 1992 Cadbury

Corresponding author: Box 870224, Alston Hall, 361 Stadium Drive, Tuscaloosa, AL 35487; Phone:

(205) 348-6097; Fax: (205) 348-0590; E-mail: smobbs@cba.ua.edu.

I am grateful to the editor (Robert Van Ness) and to two anonymousreferees for very helpful comments

and suggestions.

C2015 The Eastern Finance Association 547

548 S. Mobbs/The Financial Review 50 (2015) 547–574

report stated, “Given the importance and particular nature of the chairman’s role, it

should in principle be separate from that of the chief executive.”Almost 20 years later,

the California Public Employees’ Retirement System (CalPERS) stated, “The board

should be chaired by an independent director.”1As the CalPERS quote indicates,

those promoting separation of these two roles often advocate having an outside

chairman. However, this can be costly for many firms, especially when information

asymmetry between management and the board is high (Brickley, Coles and Jarrell,

1997). An alternative arrangement that separates the CEO from the board chair, and

yet can minimize this information asymmetry, is to havea non-CEO inside chair. This

occurs often following a succession process, initially noted by Vancil (1987), where

the retiring CEO retains the chair position while handing off the CEO title to his or

her heir, though it is not necessary that the inside chair is the former CEO. Founders

or other long-time firm employees can be an inside chair. It is also not necessary that

this organizational structure lasts only for the few months following a succession.

Firms can chose to maintain an inside chair for several years. Given their greater

board authority over the CEO, separate inside chairs are similar to outside chairs and

in certain cases can be more beneficial. Yet, current research on board leadership

devotes little attention to inside chairs and focuses primarily on outside chairs. The

purpose of this study is to examine the role of the separate inside chair on corporate

boards.

I identify any director within the Risk Metrics database classified as an employee

and with the title of chairman, but without the title of CEO, as a separate inside chair.

I do not consider inside chairs in firms in which there is also an outside chair. I

begin by examining the determinants of firms with a separate inside chair and find

that separate inside chairs are more likely in heterogeneous industries where firm-

specific human capital is more important for monitoring. I also find that a separate

inside chair is more likely in larger and, thus more complex, firms and in firms where

agency concerns are greater and when the current CEO is less experienced. Thus,

the evidence is consistent with firms with greater information asymmetry between

managers and directors being more likely to maintain a separate inside chair.

The greater ownership and historical connections with the firm create strong

incentives for inside chairs to act on behalf of shareholders, which can translate into

better board decision making and ultimately greater firm value. Consistent with this

hypothesis, I find strong evidence that inside chairs are associated with significantly

higher industry-adjusted Tobin’s Q. This finding is robust to several methods of

accounting for possible endogenous relations between the presence of a separate

inside chair and firm value. Specifically, I incorporate firm fixed effectsand a matched

control sample. I also find evidence that firms with a separate inside chair on their

board are associated with better firm operating performance.

1See section 4.9 of the 1992 Cadbury Report and section 1.4 of the 2011 CalPERS Global Principles of

Accountable Corporate Governance document.