Directors' Reputation Concerns and Decision-Making in Corporations

This paper studies the effects of the board of directors’ reputation concerns on corporate decision-making. I show that in the absence of any conflict of interest between the manager and shareholders, board’s reputation concerns may harm the firm value through the board’s reluctance to reverse bad projects. However, if the manager’s interests are significantly misaligned with the shareholders’ ones, the reputation concerns may have both positive and negative effects. The negative effect arises from the manager exploiting the board’s unwillingness to reverse bad projects. The positive effect is that the board’s reputation concerns may discipline the manager through demanding a credible proof of the project’s quality from him. I show that the negative effect is more likely to prevail when the board’s reputation concerns are high, the manager’s misalignment is particularly strong and the firm’s investment opportunities are rather attractive. In such a case, the board’s commitment to not interfere in the initial decision-making, while keeping the right to reverse projects at a later stage, increases the firm value by eliminating the impact of reputation.