Board Involvement, Director Expertise and Executive Incentives

Boards of directors have become more involved in monitoring and advising top management. We investigate how board involvement affects executive incentives in a project investment setting. To increase the probability of project success, the CEO engages in a sequence of tasks: first acquiring information to evaluate a potential project, then reporting his assessment of the project to the board, and finally implementing the project if invested. We show that board active involvement, on one hand, weakens the positive incentive spillover effect among the tasks, but on the other hand, provides incremental project-related information, which is also useful to provide incentives. As a consequence of the weakening of spillover effect, investment occurs less frequently than the first-best benchmark. Even in those cases investment efficiency is increased by board involvement, the firm value can still be lowered because board involvement may exacerbate the incentive problems. We find that the level of director expertise determines whether board involvement is beneficial for the firm but director expertise does not always improve executive incentives.