Multidimensional Corporate Governance: The Joint Design of Board Structure and Executive Compensation

Abstract

This paper provides a framework for the joint design of board structure and executive compensation. The conventional view is that as a board monitors more intensely, high-powered equity incentives are less needed. However, to monitor effectively, the board requires information from the CEO, and without proper incentives, the CEO may not share the information. We formalize this intuition and show that CEO equity incentives are determined jointly with the monitoring level and advising expertise of the board. In equilibrium: board expertise and equity incentives are substitutes (complements) when the board has high (low) monitoring; equity incentives may be positively or negatively related to board monitoring, depending on the nature of board advice; and boards with greater monitoring also have higher expertise. Our analysis sheds light on the strong correlations between board structure and executive compensation observed in empirical studies and offers new testable predictions about the clustering of governance mechanisms.

Keywords: Board monitoring, board expertise, equity incentives, corporate governance, information sharing

JEL Classification: G30, G34, D83