External Networking and Internal Firm Governance

External network ties between CEOs and directors in major U.S. corporations may limit the e¤ectiveness of internal corporate governance. Using comprehensive biographical data on the managers and directors of S&P 1500 companies, we identify connections between directors and their …rms’CEOs through external directorships, past employment, education, and other activities (e.g. golf clubs or charity organizations). Consistent with an expectation of weaker monitoring, we …nd that …rms with powerful CEOs are disproportionately likely to add directors with ties to the CEO to the board. Once on the board, such directors are more likely to buy company stock in the open market at the same time as the CEO, even though there is no evidence that they (or the CEO) have better information than other outside directors. Their companies are also less likely to do company-prompted earnings restatements. Turning to real investment choices, we …nd that acquisitions are more frequent among …rms with more connections between their directors and CEO, particularly when those directors serve on the executive committee. We also …nd that merger bids by such …rms destroy value for shareholders: on average, bidding …rms lose $354 million in the three days surrounding merger bids, $282 million more than bidders with fewer connections between the board and the CEO. Moreover, …rms with more network ties between directors and the CEO have lower aggregate market valuations than other …rms. Both valuation e¤ects are most pronounced in …rms with weak shareholder rights. Finally, we …nd little evidence that recent governance reforms have reduced the frequency of social ties between directors and their …rms’CEOs, suggesting that a broader notion of independence, which accounts for social ties between directors and management, might increase the e¤ectiveness of future governance reforms. We would like to thank Avanidhar Subrahmanyam, Mark Grinblatt, Albert Sheen and seminar participants at Oregon and UCLA for helpful comments. We acknowledge …nancial support from the Fink Center for Finance and Invesments (UCLA) and the Price Center for Entrepreneurial Studies (UCLA).