Events

Finance Seminar

Authors:

• Sudipto DASGUPTA
  The Hong Kong University of Science & Technology

• Thomas H. NOE
  University of Oxford

We model the determination of management compensation through the strategic interaction among outside shareholders, managers, and corporate boards. The board sets both regular incentive compensation and discretionary special compensation unrelated to performance. We show that shareholder value maximizing compensation plans may feature incentive compensation that is not monotone in expected performance and discretionary payments unrelated to performance. Manager oriented boards may transfer wealth to managers using compensation plans that feature a higher pay to performance relation and also exploit the discretionary compensation to enrich management. Full delegation of authority to the board, which insulates the board from shareholder outrage, may be optimal even if the likelihood of managerial control is high. However, in some cases, imposing charter restrictions on discretionary compensation is optimal. Shareholder democracy, by exposing board members to outrage costs, creates additional sources of distortion as it both induces management-oriented boards to distort operating policy to mask wealth transfers, and shareholder-oriented boards to forego optimal compensation designs to avoid shareholder suspicion. Our results have implications for several recent debates: the effect of shareholder power in shaping corporate governance, compensation-related shareholder activism, and pay transparency