Advice, Information and the Reputation of CEOs

I investigate when and how principals can use external experts to monitor agents when agents control information necessary for monitoring. In particular, I provide a theoretical model to examine in what circumstances external experts can assist boards of directors in discharging their management oversight and investment approval duties. Management controls relevant information about an investment but may not have the ability to process it to make an informed recommendation. External experts have the ability, but may not enjoy access to this information. I demonstrate how using experts to certify management recommendations a¤ects the disclosure incentives of management. Because certi…cation serves as a signaling mechanism, when managers have the incentive to truthfully reveal all that they know, certi…cation mandates are unnecessary since managers will choose to seek out second opinions. When information disclosures cannot be easily veri…ed, certi…cation mandates can be counterproductive, elevating the status of costly second opinions that always agree with management recommendations. In the absence of incentives for truthful disclosure, it is better for boards to allow management to determine when to seek second opinions, or alternatively, if second opinions are required to allow management and advisors to pool their recommendations. I am grateful to David Levine, Jean-Laurent Rosenthal and Bill Zame for their ongoing support, advice and patience. In addition, I thank Hugo Hopenhayn, Jernej Copic, Antonio Bernardi, Mark Garmaise, Anjan Thakor and participants in seminars at UCLA and Washington University in St Louis for their insightful comments; and Tracy Francis, Neal Lerner, and Tamir Maltz for helpful conversations about their own professional practices as advisors to …rms. All mistakes are, of course, my own.