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Updated 8:00 AM March 9, 2009

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Powerful CEOs can enhance firm performance

Despite the public outcry over CEO pay and abuses of authority, powerful chief executives can be good for the bottom line, a business researcher says.

E. Han Kim, professor of finance at the Stephen M. Ross School of Business, says that CEO power can enhance firm performance and enrich shareholders — as long as CEOs employ power properly.

"Recent evidence on CEO power suggests that, in general, powerful CEOs are bad news for shareholders," Kim says. "But in most corporations, the CEO position is designed to be a center of power for coordination, efficiency and organizational discipline to enhance performance.

"Power grants CEOs the ability to enhance shareholder value or further their own private benefits at the expense of shareholders. CEO power can be good, bad or benign, depending on the type of the power and how they make use of it."

Kim and doctoral student Yao Lu studied how CEO power affects firm performance and how the latter affected CEO pay for more than 2,000 U.S publicly listed firms from 1993-2006. They examined three separate dimensions of CEO power: structural power, ownership-related power and ability-based power.

Structural power is based on formal organizational structure and hierarchical authority; ownership power stems from voting rights associated with share ownership; and ability-based power rises from the expertise and prestige of a CEO to effectively make decisions.

Kim and Lu find that structural power can harm firm performance, but only when external corporate governance curbing CEO power is weak.

"Structural power helps CEOs exert their will to achieve personal objectives, one of which may be to shield themselves from the monitoring by the market for corporate control," Kim says. "Shareholders, however, would not willingly relinquish the valuable means to monitor through a controlled market unless CEOs can successfully exert their will over other executives — many of whom they appoint — and the board to get them to agree with their plans for entrenchment."

Unlike structural power, ownership power is negatively related to managerial entrenchment, the researchers say. When CEO ownership power is weak because of small-share ownership, a CEO may welcome monitoring by the market for corporate control and enjoy higher share returns and valuation associated with lower levels of entrenchment.

"However, CEO share ownership can be a double-edged sword," Kim says. "When CEOs' shares of ownership are sufficiently large to allow them to pursue private benefits of control without fear of reprisal from within their firms, they may use ownership power to shield themselves from monitoring by the market for corporate control."

On the other hand, no relationship exists between ability-based power and CEO entrenchment, the researchers say. Further, ability power is positively related to pay-for-performance sensitivity (higher pay for good performance, lower pay for poor performance) and to overall firm performance when corporate governance is strong.

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