A Dynamic Model of Managerial Entrenchment and the Positive Incentives It Creates

Abstract

This paper presents a model of entrenchment in which a CEO chooses how much effort to put into boosting the firm's productivity and the board and CEO bargain over executive-compensation and investment policies. The surplus that bargaining allocates derives from the reduction in value of the firm's capital that occurs if the CEO is replaced. Even if the CEO has no ownership stake, she exerts effort in order to increase the value of the capital at risk. This increases the shared surplus, which increases the CEO's current pay. Investment increases the surplus to be shared, increasing the CEO's future pay.

Keywords: corporate governance, entrenchment, executive compensation, Nash bargaining solution, ownership-based incentives

JEL Classification: C78, D25, G34, G35, M12