Competition for Managers, Corporate Governance, and Incentive Compensation

by Viral Acharya from New York University, for The Harvard Law School Forum on Corporate Governance and Financial Regulation,  May 10, 2

In the paper, Competition for Managers, Corporate Governance, and Incentive Compensation, which was recently made publicly available on SSRN, my co-authors (Marc Gabarro and Paolo Volpin, both at London Business School) and I theoretically explore the joint role played by corporate governance and competition among firms to attract better managers. In our principal agent problem, there are two ways to induce the manager to make the right decision: paying compensation in case of better performance and investing in corporate governance to punish managers if things go badly. We show that when managerial ability is observable and managerial skills are scarce, competition among firms to hire better managers implies that in equilibrium firms will choose lower levels of corporate governance. Intuitively, the result follows from the fact that managerial rents cannot be influenced by an individual firm but instead are determined by the value of managers when employed somewhere else. Hence, if a firm chooses a high level of corporate governance, the remuneration package will have to increase accordingly to meet the participation constraint of the manager. It is therefore firms (and not managers) that end up bearing the costs of higher corporate governance with little benefit….(continue reading)

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