The impact of hiring directors' choice‐supportive bias and escalation of commitment on CEO compensation and dismissal following poor performance: A multimethod study

• DOI: http://doi.org/10.1002/smj.3092
• Author: Michelle L. Zorn,James G. Combs,David J. Ketchen,Kaitlyn DeGhetto
• Date: 01 February 2020
• Published date: 01 February 2020

RESEARCH ARTICLE

The impact of hiring directors' choice-supportive

bias and escalation of commitment on CEO

compensation and dismissal following poor

performance: A multimethod study

Michelle L. Zorn

1

| Kaitlyn DeGhetto

2

| David J. Ketchen Jr

1

|

James G. Combs

3,4

1

Raymond J. Harbert College of Business, Auburn University, Auburn, Alabama

2

School of Business Administration, University of Dayton, Dayton, Ohio

3

Enterprise College of Business, University of Central Florida, Orlando, Florida

4

Telfer School of Management, University of Ottawa, Ontario, Canada

Correspondence

Michelle L. Zorn, Raymond J. Harbert

College of Business, Auburn University,

405 W. Magnolia Ave, Auburn, AL 36849.

Email: mzorn@auburn.edu

Abstract

Research Summary:Boards of directors make high-stake

decisions that involve hiring, compensating, and dis-

missing CEOs. Building on theory about choice-supportive

bias and escalation of commitment, we theorize that “hir-

ing directors”(directors who were present during a CEO's

hiring) will display choice-supportive bias and escalate

commitment to poorly performing CEOs. Primary data

from 73 directors indicate that directors are indeed biased

toward CEOs they help hire. Archival data from S&P 1500

firms reveal that, following poor performance, the number

of hiring directors is positively related to the increase in

CEO pay and lower likelihood of CEO dismissal. Building

on theory about board experience, we also predict and find

that more experienced boards reduce the tendency to esca-

late. Thus, bias among hiring directors can be mitigated

via experience.

Managerial Summary:Making a choice such as casting a

vote or selecting a restaurant leads people to view their

selection favorably even if evidence emerges suggesting it

was a bad choice. We examine whether corporate directors

Received: 11 September 2018 Revised: 26 July 2019 Accepted: 14 August 2019 Published on: 15 October 2019

DOI: 10.1002/smj.3092

308 © 2019 John Wiley & Sons, Ltd. Strat Mgmt J. 2020;41:308–339.wileyonlinelibrary.com/journal/smj

fall prey to this choice-supportive bias when involved in

CEO hiring. We found that directors who are part of the

hiring process tend to have an overly rosy view of the per-

son selected. Moreover, if the firm is performing poorly, a

board with more directors who helped hire the current

CEO will tend to increase the CEO's pay more and are less

likely to fire the CEO than a board with fewer such direc-

tors. This problem is reduced if the board has highly expe-

rienced directors among its ranks.

KEYWORDS

board of directors, CEO compensation, CEO dismissal, cognitive bias,

corporate governance

1|INTRODUCTION

“Board members don't want to look like they made a mistake—maybe they chose the

wrong horse.”

- A director serving on two corporate boards

Hiring, compensating, and firing CEOs are key tasks for corporate directors. Directors strive to select

talented leaders, pay them appropriately, and, when necessary, release them if performance falls below

expectations. Given the high stakes involved, it is not surprising that scholarly interest lies in under-

standing factors that shape directors' decision-making (e.g., Boivie, Bednar, Aguilera, & Andrus,

2016; Graffin, Boivie, & Carpenter, 2013). Shareholders expect board members to be as objective and

logical as possible, but like all humans, corporate directors are imperfect information processors

whose cognitive biases can influence their decisions (compare March & Simon, 1958), especially if

they are unaware of the biases. Past research shows that directors are influenced by social factors such

as CEO ingratiation behaviors (Westphal & Shani, 2016; Westphal & Stern, 2007), they use heuristics

when evaluating and compensating recently appointed CEOs (Graffin et al., 2013), and they make

incorrect assumptions about what other directors believe (Westphal & Bednar, 2005). Left

unaddressed is how directors' involvement in a decision can distort their subsequent decisions. This is

a significant omission because psychology (Batson, 1975), entrepreneurship (Guler, 2007), marketing

(Schmidt & Calantone, 2002), and political science (Achen & Bartels, 2006) research indicates that

involvement in a decision biases decision-makers toward their selected choice.

For directors who help hire a CEO (whom we refer to as “hiring directors”for simplicity of exposi-

tion), involvement in the CEO selection process might result in a favorable tendency known as choice-

supportive bias toward the selected person. Choice-supportive bias is the unwitting tendency to mis-

remember prior choices such that favorable aspects are exaggerated, and unfavorable aspects are down-

played (Mather & Johnson, 2000; Mather, Shafir, & Johnson, 2000). This results in decision-makers

supporting their choice and continuing to believe it is the best available option even after confronting

seemingly contradictory information. Perhaps because of the credentials directors must possess to gain

entry into the corporate elite (e.g., Westphal & Khanna, 2003), researchers often assume that directors

ZORN ET AL.309

are relatively rational decision-makers (e.g., Cuevas-Rodríguez, Gomez-Mejia, & Wiseman, 2012).

This fuels a need to discover whether directors have a reduced susceptibility to choice-supportive bias

or whether this bias plagues directors as itdoes people in general.

Choice-supportive bias merits investigation in part due to the potential that it may foster escala-

tion of commitment (i.e., “the tendency to ‘carry on’with questionable endeavors, regardless of

whether doing so is likely to result in success”—Sleesman, Lennard, McNamara, & Conlon, 2018,

p. 178; Staw, 1976, 1981). Reviews of research on escalation of commitment establish the role of

several cognitive antecedents, such as threats to one's ego, that involve a self-justification process

wherein decision-makers rationalize prior choices to themselves (Sleesman et al., 2018; Sleesman,

Conlon, McNamara, & Miles, 2012). If evidence later emerges that suggests the choice was unwise,

this process helps decision-makers reduce feelings of regret (Festinger, 1957; Staw, 1997). Applied

to the boardroom setting, directors who helped hire the CEO might develop a favorable bias toward

the CEO as a product of their involvement in the CEO's selection. If faced with evidence of poor

financial performance, we theorize that choice-supportive bias toward the CEO triggers escalation of

commitment, which can lead to suboptimal decision-making.

Building on theory about choice-supportive bias and escalation of commitment, we aspire to offer

three main contributions. First, while substantial interest lies in understanding the factors that influence

directors' strategic decision-making (e.g., Boivie et al., 2016), possible problems arising from being

involved in CEO selection remain unexamined. Accordingly, our first intended contribution is exten-

ding knowledge about directors' decisions by theorizing and providing evidence that hiring directors

suffer from choice-supportive bias. In doing so, we respond to the concern that “research on boards and

corporate governance has heavily relied on unquestioned behavioral assumptions…and a majority of

empirical studies treat behavioral interactions and decision-making processes largely as intervening

unmeasured constructs”(van Ees, Gabrielsson, & Huse, 2009, p. 308). Indeed, numerous authors have

observed a “black box problem of associating board variables and firm performance”without tapping

into underlying mechanisms (Johnson, Schnatterly, & Hill, 2013, p. 229). We take a step toward

unveiling this black box by theorizing about a specific cognitive bias and gathering relevant primary

data from directors. Directors have unique credentials that might reduce susceptibility to biases found

in the general population, so it is important to understandwhich biases exert influence at this level.

Second, we connect choice-supportive bias to escalation of commitment by investigating whether

the directors subject to choice-supportive bias toward the CEO—i.e., hiring directors—show escala-

tion of commitment to the CEO in the face of negative feedback. Escalation of commitment to a

struggling course of action can have devastating consequences for shareholders, employees, and

other stakeholders (Sleesman et al., 2018). We expect escalation in our context to take the form of an

increase in pay for poorly performing CEOs and—as reflected in our opening epigram—a reluctance

to fire poorly performing CEOs.

Connecting choice-supportive bias to escalation is important because it offers a boundary condi-

tion to prior theorizing. Building on the social exchange theory, past research suggested that directors

appointed after (and by) the CEO are biased toward the CEO because they feel loyalty in exchange

for their board seats (e.g., Boeker, 1992; Core, Holthausen, & Larcker, 1999; Main, O'Reilly, &

Wade, 1995; Shivdasani & Yermack, 1999; Wade, O'Reilly, & Chandratat, 1990). Such loyalty may

be of less concern when CEOs do not play a formal role in director selection—as became the case in

the USA after the 2002 Sarbanes–Oxley Act (SOX) and rule changes at leading exchanges

(e.g., NYSE; NASDAQ) significantly reduced the role that CEOs have in the formal selection pro-

cess. Thus, within today's regulatory environment where feelings of loyalty to the CEO for board-

seats are likely reduced, choice-supportive bias and subsequent escalation of commitment among

310 ZORN ET AL.