Outside investor access to top management: market monitoring versus managerial bias

Abstract

Voluntary disclosure can lower the cost of capital and improve market monitoring
of managers. However, market participants may be uncertain about how
much managers intend to bias any voluntary disclosure. Firm owners can adjust
managerial compensation to mitigate uncertainty about managerial bias. This
paper builds an optimal-contracting model to show how reductions in cost of
capital and higher sensitivities of equity pay to performance need to be traded
off against distortions in managerial compensation. The model predicts that,
across firms, voluntary disclosure is positively related to managers’ bias and
strength of equity incentives, and negatively to the cost of capital.

Keywords: Managerial compensation contracts, Biased voluntary disclosure, Market monitoring, Cost of capital

JEL Classification: D82, D86, G14, G32, G34, M12, M41