Competition for Managers, Corporate Governance and Incentive Compensation

Viral V. Acharya, Marc Gabarro, Paolo F. Volpin
2011 Social Science Research Network  
We propose a model in which ...rms compete to attract better managers using corporate governance as part of an optimal executive compensation scheme. In our setting, higher corporate governance decreases the cost of taking disciplinary actions against managers. When managerial talent is scarce, we show that competition among ...rms to attract better managers implies that ...rms choose lower levels of corporate governance. The reason is that managerial rents are determined by the managerial
more » ... the managerial reservation value when employed elsewhere. Hence, if a ...rm chooses a high level of governance, the remuneration package and pay for performance has to increase to meet the managerial reservation value. It is therefore the ...rm, and not the manager, that ends up bearing the costs of higher governance. We also provide empirical support for the model. First, we show that a ...rm's executive compensation is not chosen in isolation but it also depends on other ...rms'corporate governance. Then, we document that ...rms use (weak) corporate governance as a substitute for executive compensation to attract better managers. In particular, better managers are matched to ...rms with weaker corporate governance. JEL classi...cation: D82, G21, G18.
doi:10.2139/ssrn.1786703 fatcat:cqcmrklwrfgilhn2b44c4diz3i