Managerial Entrenchment and the Market for CEOs
Tilburg University - Department of Finance
February 14, 2009
This paper provides an explanation for why increased board independence might induce higher CEO pay. I propose a simple model in which managers have private benefits of control and may become entrenched. Managers have unknown ability which affects their performance, and derive incentives from turnover in the labor market. Successful managers obtain higher compensation and retain private benefits. Failing managers, on the contrary, reveal to be less skilled, are fired, and lose their private benefits. Entrenchment allows failing managers to keep their job with some probability, and has two effects on the managerial labor market. First, it prevents captured companies from seeking better managers: this demand effect reduces the equilibrium pay of CEOs and weakens career concerns. Second, entrenchment decreases the number of successful managers: this supply effect increases the equilibrium pay of CEOs and strengthens career concerns. The model predicts that if the probability of firing an entrenched manager is small, the demand effect dominates, and a reduction in the ex-ante probability of entrenchment increases managerial compensation.
Number of Pages in PDF File: 24
Keywords: Executive Compensation, Managerial Entrenchment, Career Concerns
JEL Classification: D83, D86, G34working papers series
Date posted: February 14, 2009
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