AI in the Boardroom: An Unseen Challenge to Governance 

How AI impacts the relationship between the CEO and the Board

The rise of artificial intelligence is fundamentally changing the dynamic between CEOs and corporate boards by affecting the flow of information and decision-making processes. The traditional model, where a CEO relies on a board's advice for complex problems, is being disrupted as AI offers a new source of insights. This shift creates a need to adapt governance structures to maintain effective oversight.

The Double-Edged Sword of AI

The academic paper "Artificial Intelligence in the Boardroom" by Daniel Ferreira and Jin Li  identifies two key capabilities of AI:

problem-solving and skill-augmenting.

• Problem-solving capability allows AI to act as a substitute for human judgment. A CEO with access to this type of AI may bypass the board for solutions, reducing their incentive to share information. This diminished information flow makes it harder for boards to monitor management effectively, which can lead to increased CEO entrenchment and a decrease in CEO turnover. This is an inefficient outcome that ultimately destroys firm value because less competent CEOs are retained when better replacements are available.

• Skill-augmenting capability enhances a CEO's ability to perform tasks and solve problems. This makes the CEO more productive, which can be value-enhancing for the firm. However, even with this positive effect, the CEO's increased self-sufficiency reduces their need for the board's advice.

The Impact on Governance and Compensation

The integration of artificial intelligence into executive decision-making presents a subtle but significant challenge to corporate governance. When chief executives utilise AI as an advisory tool, their reliance on the board for strategic counsel diminishes. This creates a new information dynamic, potentially reducing the CEO's incentive to share critical information with directors, especially if that information reflects poorly on performance.

Our analysis reveals that organisations must adapt to this new reality. To maintain essential information flows, firms are compelled to reduce the independence of their boards, fostering a more 'CEO-friendly' environment. While this restores communication, it comes at a cost. A lower intensity of board monitoring leads to decreased CEO turnover and greater entrenchment. Consequently, with the risk of dismissal lessened, firms can and do reduce overall CEO compensation. This highlights an unintended consequence of AI adoption that boards and shareholders must proactively manage.

Firms must therefore adjust their governance strategies to encourage CEOs to communicate with the board. This adjustment is necessary to restore the flow of information, but it comes at a cost.  The overall effect on firm value is ambiguous and depends on the relative strength of AI's capabilities. If AI is primarily used as a substitute for board advice, it can reduce a firm's total welfare. When boards also adopt AI, they can mitigate some of these negative effects, but only if the technology's advancements are sufficiently biased toward enhancing the board's capabilities more than the CEO's.

Broader Implications for Organisations

This dynamic extends beyond the boardroom to any organisational setting where an agent needs to be incentivised for both effort and truthful communication. For example, a sales manager might see their agents use AI to handle customer issues more efficiently, leading to a decrease in reporting on challenges. In essence, AI can paradoxically increase the costs associated with incentives by changing the value of an agent's off-equilibrium decisions, such as choosing not to seek help. Organisations that fail to adapt their governance structures risk experiencing worse outcomes after adopting AI than they did before.