Corporate Governance, Takeovers, and Top-Management Compensation: Theory and Evidence

Management Science, Vol. 48, No. 4, April 2002

Posted: 1 May 2002

See all articles by Richard Cyert

Richard Cyert

Formerly affiliated with Carnegie Mellon University - Graduate School of Industrial Administration (GSIA)

Praveen Kumar

University of Houston - Department of Finance

Sok-Hyon Kang

George Washington University - School of Business

Abstract

We examine, both theoretically and empirically, top-management compensation in the presence of agency conflicts when shareholders have delegated governance responsibilities to a self-interested Board of Directors (BOD). We develop a theoretical framework that explicitly incorporates the BOD as a strategic player, models the negotiation process between the CEO and the BOD in designing CEO compensation, and considers the impact of potential takeovers by large shareholders monitoring the CEO-BOD negotiations. In equilibrium, internal governance by the BOD and external takeover threats by a large shareholder act as substitutes in imposing managerial control, especially in constraining management's profligacy in awarding equity-based compensation to itself. The model emphasizes factors in the design of compensation contracts that are rarely considered in the literature, such as equity ownership of the largest outside shareholder and the firm's bankruptcy risk. It also provides an alternative perspective on factors that are often considered in the literature, such as firm size, firm performance, equity ownership of the BOD, and BOD structure. Our empirical tests lend considerable support for our theoretical predictions. Equity ownership of the largest external shareholder, that of the BOD, and the default risk, are strongly negatively related to the size of CEO equity compensation. Consistent with the theoretical model, these factors do not significantly influence the growth of fixed (or non-performance related) compensation. We also find that the equity ownership of the BOD is more important in managerial compensation control than other BOD related variables, such as BOD size or the proportion of outside directors.

Note: This is a description of the paper, and not the actual abstract.

Keywords: corporate governance and board of directors, takeover threats, stock options and CEO compensation, default risk

JEL Classification: G34, G32, J33

Suggested Citation

Cyert (deceased), Richard and Kumar, Praveen and Kang, Sok-Hyon, Corporate Governance, Takeovers, and Top-Management Compensation: Theory and Evidence. Management Science, Vol. 48, No. 4, April 2002, Available at SSRN: https://ssrn.com/abstract=299441

Richard Cyert (deceased)

Formerly affiliated with Carnegie Mellon University - Graduate School of Industrial Administration (GSIA)

N/A

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Sok-Hyon Kang

George Washington University - School of Business ( email )

405 Government Hall
GWU
Washington, DC 20052
United States
(202) 994-6058 (Phone)
(202) 994-5164 (Fax)

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