Executive Compensation: A Model of Disclosure Choice

37 Pages Posted: 18 Dec 2013

See all articles by Pascal Frantz

Pascal Frantz

London School of Economics

Norvald Instefjord

University of Essex - Essex Business School

Martin Walker

University of Manchester - Manchester Business School

Date Written: November/December 2013


Recent public policy debates have led to increased calls for full transparency of executive compensation. However, in practice, many firms are reluctant to disclose the full details of how they link executive compensation to performance. One possible reason for lack of full disclosure is that managers use their power to hide the details of their compensation plan in order to disguise opportunistic rent extraction. If this is the reason for secrecy, then public policy designed to force firms to provide full disclosure is unlikely to be resisted by shareholders. However, another possible explanation for less than full transparency is that some degree of secrecy about executive compensation may be in the interest of the company and its shareholders. If this explanation is correct, then public policy moves to increase transparency may be met by counter moves designed to protect managers and shareholders from such policies. In this paper we investigate if full disclosure of executive compensation arrangements is always optimal for shareholders. We develop a model where optimal executive remuneration solves a moral hazard problem. However, the degree to which the moral hazard problem affects the shareholders depends on hidden information, so that disclosure of the executive compensation scheme will typically reveal the hidden information, which can be harmful to shareholders. The model derives, therefore, the optimal disclosure policy and the optimal remuneration scheme. We find that the shareholders are better off pre‐committing not to disclose the executive compensation scheme whenever possible. Executive directors are shown to be better off too in the absence of disclosure of executive compensation schemes. An argument for mandating disclosure is that it provides better information to shareholders but our analysis demonstrates that disclosure does not necessarily achieve this objective. The results suggest that less than full disclosure can be in the interest of shareholders, the reason for this being that disclosures cannot be made selectively to shareholders but will also be made to strategic opponents. This will be the case if the board of directors and the remuneration committee includes enough independent directors. Whether or not non‐disclosure to shareholders is in their interest is however an empirical matter involving a trade‐off between the proprietary costs associated with disclosure to shareholders and the costs of potential collusion between executive and non‐executive directors associated with non‐disclosure.

Keywords: executive compensation, corporate governance, voluntary disclosure, strategic opponent, agency setting, economic welfare

Suggested Citation

Frantz, Pascal and Instefjord, Norvald and Walker, Martin, Executive Compensation: A Model of Disclosure Choice (November/December 2013). Journal of Business Finance & Accounting, Vol. 40, Issue 9-10, pp. 1184-1220, 2013, Available at SSRN: https://ssrn.com/abstract=2369087 or http://dx.doi.org/10.1111/jbfa.12041

Pascal Frantz (Contact Author)

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
442079557233 (Phone)
442079557420 (Fax)

Norvald Instefjord

University of Essex - Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Martin Walker

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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