Figureheads or potentates? CEO power and board oversight in the context of Sarbanes Oxley

Research question/issue We depart from studies that separately explore chief executive officers' (CEOs') and boards' effects on firm performance. Instead, we examine the direct relationship between CEO power and firm performance, and how board monitoring, and most importantly, a change in the regulatory environment alter the relationship. As such, our study jointly examines the role of both internal and external corporate governance mechanisms on the relationship between CEO power and firm performance. Research findings/insights Our findings indicate that the negative main effect of a powerful CEO on firm performance is reduced by board monitoring and that the Sarbanes Oxley (SOX) legislation amplifies board monitoring and reduces the negative effects of CEO power. Theoretical/academic implications Our study shows that agency relationships are grounded in social and institutional contexts. More precisely, our results suggest that CEO power is a function of CEO's relationship with the board, as CEO power and board monitoring interactions affect firm performance. Furthermore, they indicate that the CEO‐board relationship is constructed within the legal institutional context, as the shock of SOX alters the effects that different combinations of CEO power and board monitoring have on firm performance. Practitioner/policy implications Our results highlight to investors and directors that corporate boards should be designed in relation to the power of CEOs. In addition, they provide valuable guidance for policy‐makers, suggesting that tight regulations may represent effective deterrents for some CEOs' misbehaviors and favor the alignment of interests with those of company owners.