Mutual Monitoring and Agency Problems
40 Pages Posted: 13 Feb 2011 Last revised: 5 Jun 2019
Date Written: May 1, 2019
Mutual monitoring in a well-structured authority system can mitigate the agency problem. I empirically examine whether the number 2 executive in a firm, if given authority, incentive, and channels for communication and influence, is able to monitor and constrain the potentially self-interested CEO. I find strong evidence that: (1) measures of the presence and extent of mutual monitoring from the No. 2 executive are positively related to future firm value (Tobin’s Q); (2) the beneficial effect is more pronounced for firms with weaker corporate governance or CEO incentive alignment, and with higher information asymmetry between the boards and the CEOs; (3) such mutual monitoring reduces the CEO’s ability to pursue the “quiet life” but has no effect on “empire building;” and (4) mutual monitoring is a substitute for other governance mechanisms. The results suggest that mutual monitoring provides checks and balances on CEO power.
Keywords: Corporate governance, Mutual monitoring, Authority differential, Pay gap, Agency problem, No. 2 executive, Firm performance
JEL Classification: G34, G32, D23, J33
Suggested Citation: Suggested Citation