CEO-Director Social Clustering and Firm Value

Using an extensive database that covers the social networks of business executives, we identify “social clustering” of CEOs and directors of S&P 1500 firms, roughly defined as close knit communities within a network, and study its effects on corporate governance and firm value. Prior literature has shown that network clustering improves information transmission and strengthens informal contracting, but may also induce excessive loyalty, homogenization of ideas, or propagate the effects of shocks throughout the network. We find that the degree to which a CEO and her directors overlap in social communities affects the governance of the firm and that these effects are conditional upon the potential for adverse reputation costs faced by the members of the board. For firms whose boards face relatively lower potential adverse reputation costs to bad behavior, clustering is associated with poorer governance and managerial self-dealing. For firms whose boards face relatively higher potential adverse reputation costs to bad behavior, clustering acts as an implicit enforcement mechanism complementary to explicit firm governance.