Board Structure, Product Market Competition and Incentive Compensation

Abstract:     
This paper examines the interactions among three corporate-governance mechanisms; board structure, product market competition, and incentive compensation. While the interaction between product market competition and incentive compensation has been evaluated in the literature before, little is known about the extent of how the relationship between these two corporate-governance mechanisms be affected by a change in the board structure, which in itself is also a corporate-governance mechanism. Board structure and product market competition serve as monitoring devices that provide a disciplinary 'stick' to managers to ensure that they serve the best interests of the owners. The former is an internal monitoring device, while the latter is an external monitoring device. In contrast, incentive compensation provides a 'carrot' to align the incentive of managers with that of the owners. Existing studies have shown that product market competition may either be substitute for- or complement to incentive compensation. This paper focuses on how a change in board structure influences the existing relationship between product market competition and incentive compensation. In particular, we evaluate the change in the board structure following the enactment of the Sarbanes-Oxley (SOX) law on the strength of incentive compensation provision. Our results show that the direction of influence of the SOX law on the incentive compensation provision crucially depends on the intensity of product market competition.

Number of Pages in PDF File: 40

Keywords: corporate governance mechanisms, board structure, product market competition, incentive compensation, Sarbanes-Oxley, program evaluation, propensity score matching

JEL Classification: C21, G32, G34, L11

working papers series