Legal Institutions, Board Diligence, and Top Executive Pay

Abstract

We examine whether anti-director laws and legal director liability rules matter for whether directors act diligently in setting the compensation of CEOs. The study uses a world-wide data set covering 27 countries for the period 1995 to 2005. Controlling for a number of legal and economic determinants, we find that independent of managerial risk-aversion, CEO pay is always less generous under stricter anti-director rules and a stronger rule of law. Director liability rules are associated with more generous pay schemes. The results persist once we control for the presence of institutional investors and cross-listing in the U.S. We interpret our findings in the sense that anti-director right make boards more accountable to shareholders. As a consequence, directors tend to act more diligently when negotiating the pay contract with the CEO. Previous research identified lower economic performance of firms from civil law countries. Our study suggests that the presence of less diligent boards in these countries may contribute to this result. Moreover, our findings indicate that governmental anti-director rules are not completely substitutable by private measures of governance.

Keywords: CEO authority, corporate governance, comparative

JEL Classification: C23, G38