Article,
CEO Duality as a Double-Edged Sword: How Boards of Directors Balance Entrenchment Avoidance and Unity of Command
Academy of Management Journal, 37 (5): 1079--1109 (October 1994)
Abstract
Presents a contingency framework to resolve the perspectives on the dual role that a chief executive officer (CEO) plays when he is also the chairperson of its board. Agency theory and duality; Organization theory; Contingencies affecting management of CEO duality; Theoretical and practical implications.
When a firm's chief executive officer is also the chairperson of its board, directors have opposing objectives. According to organization theory, such CEO duality establishes strong, unambiguous leadership. But according to agency theory, duality promotes CEO entrenchment by reducing board monitoring effectiveness. We developed a contingency framework to resolve these perspectives. Sampling three industries to enhance generalizability, we found that board vigilance was positively associated with CEO duality. Duality was less common, however, when CEOs had high informal power and when firm performance was high.
Boards of directors are charged with ensuring that chief executive officers (CEOs) carry out their duties in a way that serves the best interests of shareholders (Vance, 1983). Thus, boards can be seen as monitoring devices that help align CEO and shareholder interests (Fama & Jensen, 1983). Although monitoring activity can take many forms, such as designing compensation contracts and hiring and firing CEOs (Walsh & Seward, 1990), in this study we focused on structural arrangements, specifically, the incidence of CEO duality. CEO duality occurs when the same person holds both the CEO and board chairperson positions in a corporation (Rechner & Dalton, 1991). CEO duality has opposing effects that boards must attempt to balance. On the one hand, duality can firmly entrench a CEO at the top of an organization, challenging a board's ability to effectively monitor and discipline (Mallette & Fowler, 1992).(n1) On the other hand, the consolidation of the two most senior management positions establishes a unity of command(n2) at the top of the firm, with unambiguous leadership clarifying decision-making authority and sending reassuring signals to stakeholders.
The juxtaposition of these two perspectives and the underlying theories that support them make the study of CEO duality compelling. Advocates of agency theory, which focuses on monitoring and entrenchment, argue that avoiding duality limits potential CEO entrenchment. Proponents of organization theories, which focus on issues of structure, leadership, and legitimacy, argue that duality enhances unity of command. Thus, CEO duality can be conceptualized as a double-edged sword forcing boards to choose between the contradictory objectives of unity of command and entrenchment avoidance. The double-edged nature of CEO duality makes this study especially relevant to research on corporate governance. Although there is much work in organization theory on the substantive, symbolic, and practical value of unity of command (Barnard, 1938; Fayol, 1949; Pfeffer, 1981a) and a somewhat shorter but no less compelling history of agency theory research on entrenchment avoidance (Fama & Jensen, 1983; Morck, Shleifer, & Vishny, 1988), studying CEO duality makes it apparent that it is not easy to simultaneously establish unity of command at the top and avoid CEO entrenchment.
Although the theoretical perspectives noted lead to opposing predictions on CEO duality and appear to be in conflict, an important goal of this study was to develop a contingency framework showing how these theories are actually complementary. Thus, we propose and test a model that explains a firm's propensity to use or avoid a dual CEO structure.
Central to our model is the recognition that CEO duality is not always dysfunctional, as research in agency theory would suggest,(n3) and that nonduality is not always dysfunctional, as research in organization theory would suggest. We argue that vigilant boards, defined as boards that have the motivation and incentive to effectively monitor and discipline CEOs, will favor either duality or nonduality in specific circumstances. The two contingency variables we focused on, informal CEO power and firm performance, determine whether vigilant boards favor CEO duality or nonduality. When either informal CEO power or firm performance is high, the risk of CEO entrenchment is also high, making duality more dysfunctional. When informal CEO power or firm performance is low, CEO entrenchment is less likely to occur, and there is pressure for strong leadership, making nonduality more dysfunctional. Thus, board attempts to balance avoiding entrenchment and achieving unity of command really depend on three interrelated factors: board vigilance, informal CEO power, and firm performance.
A focus on this model and on CEO duality in general is important for several reasons. First, in spite of the increasing importance of corporate governance issues to research on organizations, there has not been scholarly work on the determinants of CEO duality, and in particular, on the circumstances that affect whether or not vigilant boards employ the dual structure. To date, there is a significant but limited body of research on CEO duality. In a recent study of the Fortune 500, Rechner and Dalton (1991) reported that CEO duality was negatively associated with firm performance. However, several other studies have found performance and duality to be unrelated (Berg & Smith, 1978; Chaganti, Mahajan, & Sharma, 1985; Daily & Dalton, 1992). Hence, previous work has yielded mixed results and has focused exclusively on the main effect of duality on firm performance; we studied firm performance in a new way--both as a determinant of duality and as a contingency variable in the board vigilance-duality relationship. A second reason this study is important is that, as noted, both CEO duality and nonduality may be dysfunctional in different circumstances. Hence, given that agency theory and organization theory offer seemingly contradictory perspectives on board preferences, a study that could help integrate these theories seemed warranted. And third, there appears to be considerable practitioner interest in the duality question (White, 1992), suggesting that our analysis may have important managerial implications.
