Managerial Entrenchment and the Market for Talent

Abstract

This paper studies how the nature of managerial skills affects firms’ governance decisions. As required skills shift from firm specific toward more general abilities, replacing an underperforming CEO with an outside hire becomes more profitable for shareholders. Therefore, firms adopt stronger governance arrangements to limit the entrenchment of incumbent CEOs and exploit the improved opportunities offered by the market for talent. The analysis rationalizes the observed trend toward stronger corporate governance and offers novel empirical predictions concerning the relationship between managerial entrenchment, firm size, and the nature of managerial skills. (JEL D83, D86, G34)