The sheep watching the shepherd: The monitoring performance of boards with employee representation

The board of directors play a key role in monitoring management. However, for an effective monitoring, information asymmetry between the boards and management is an obstacle. In this paper we focus on the role of employee representative and how they contribute to the ability of the boards for monitoring CEO compensation and overseeing financial reporting. In particular, employee representative can provide the outside directors with inside information and alleviate the information asymmetry between managers and board of directors. Using a sample of listed firms in Stockholm Stock Exchange allows us to study the impact of co-determination on firm's corporate policies more closely. In particular, we find evidence for a higher earnings quality in firms with employees on the boards, suggesting that these firms are less engaged in earnings management. Furthermore, with respect to CEO compensation, there is some evidence that the presence of employee representatives on the boards is negatively associated with CEO equity incentive plans.