CEO Power, Compensation and Governance
Rui A. Albuquerque
Boston University - Questrom School of Business; Católica-Lisbon School of Business and Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
Boston University - Department of Economics
CEPR Discussion Paper No. 5818
This paper presents a contracting model of governance based on the premise that CEOs are the main promoters of governance change. CEOs use their power to extract higher pay or private benefits, and different governance structures are preferred by different CEOs as they favour one or the other type of compensation. The model explains why good countrywide investor protection breeds good firm governance and predicts a 'race to the top' in firm-governance quality after the Sarbanes-Oxley Act. However, such governance changes may be associated with higher rather than lower CEO pay as CEOs substitute away from private benefits. The model also provides an explanation for the observed correlation of CEO pay and firm governance based on CEO power. Finally, we discuss the optimality of introducing randomness in CEO hiring, for example, by evaluating CEOs based on qualitative characteristics, or soft skills, that are prone to diverse judgements.
Number of Pages in PDF File: 40
Keywords: CEO power, moral hazard, CEO compensation, investor protection
JEL Classification: G34, J33, K00
Date posted: October 13, 2006
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