Board Monitoring and Endogenous Information Asymmetry

Boards of directors are frequently criticized for their lack of monitoring in executive decision making. Increasing board effort to reduce information asymmetry between executives and shareholders is commonly viewed as desirable. This study challenges this common view by demonstrating that active monitoring can reduce the CEO’s incentives to exert effort to acquire useful information for decision making. In particular, I model a CEO who has superior ability to acquire, process and interpret information relevant to investment decisions. I show that a board that actively solicits information from the CEO is beneficial only if the board is able to provide a sufficiently accurate evaluation of the information acquired by the CEO. If the board does not have the expertise to provide such an evaluation, it is better for the board to be passive and not interfere with the CEO’s decisions. My findings highlight the subtleties in monitoring an expert and show that when the board does not have the expertise, information asymmetry is endogenously created to provide incentives for CEOs to make efficient investment decisions.