Title Board Compensation and Investment Efficiency 

Keywords: Board monitoring, director compensation, investment inefficiency

Abstract:

In their role as initiators of new business projects, CEOs have an advantage over access to and control over project-related information. This exacerbates pre-existing agency frictions and may lead to investment inefficiencies. To counteract this challenge, incentive compensation for corporate boards (responsible for approving major projects) emerges as a critical governance tool. Our study demonstrates that the optimal compensation design requires strategically allocating a liability burden between CEOs and boards. When this burden is shifted onto the boards, shareholders reduce management rents, albeit at the expense of residual inefficiency. Our findings thus highlight that shareholders’ tolerance for investment inefficiencies may be rooted in optimal compensation.

We predict that contracts tolerating excessive investments are optimal under conditions of low labor market value for CEOs, severe CEO empire-building, and attractive outside options for directors. Because of structural changes associated with the reallocation of financial incentives, the non-financial characteristics of CEOs and boards may impact investment efficiency, information quality, project profits, and management rents in a non-monotonic manner.

Bio:

Martin Gregor is an applied theorist interested in corporate finance, corporate governance, organizational economics, and accounting and economics. His papers have been cited, among others, in top journals in Finance (Review of Financial Studies), Management (Management Science), Accounting (Journal of Accounting Research), and Political Science (Americal Political Science Review). His work has been presented, among others, at MIT Sloan, Chicago Booth, Wharton, Stanford Graduate School of Business, Kellogg School of Management, NYU Stern School of Business, and Yale School of Management.

https://sites.google.com/view/mgregorecon

Link to Paper:

https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=2454829