Corporate Governance, Executive Compensation and Securities Litigation

46 Pages Posted: 29 Apr 2004

See all articles by Eric L. Talley

Eric L. Talley

Columbia University - School of Law; European Corporate Governance Institute (ECGI)

Gudrun Johnsen

Danmarks Nationalbank

Date Written: May 4, 2004


It is generally accepted that good corporate governance, executive compensation and the threat of litigation are all important mechanisms for incentivizing managers of public corporations. While there are significant and robust literatures analyzing each of these policy instruments in isolation, their mutual relationship and interaction has received somewhat less attention. Such neglect is mildly surprising in light of a strong intuition that the three devices are structurally related to one another (either as complements or substitutes). In this paper, we construct an agency cost model of the firm in which corporate governance protections, executive compensation levels, and litigation incentives are all endogenously determined. We then test the predictions of the model using a firm-level data set including governance, executive compensation, and securities litigation variables. Consistent with our predictions, we find governance and compensation to be structural substitutes with one another, so that more protective governance structures tend to coincide with lower-powered incentives in executive contracts. Also consistent with our predictions, we find executive compensation and shareholder litigation appear to be structural complements to one another, so that higher powered incentives tend to catalyze more frequent litigation. In fact, we estimate that each 1% increase in the incentive component of a CEO's contract predicts 0.3% increase in the likelihood of a securities class action and a $3.4 million dollar increase in expected settlement costs. In addition, the complementarity of executive compensation and litigation allows us to formulate new ways to test for the effects of legal reform, such as the Private Securities Litigation Reform Act of 1995. The results of our preliminary tests appear inconsistent with the claims of the statute's proponents that the PSLRA systematically discouraged non-meritorious litigation without burdening meritorious claims, particularly for firms with relatively low volatility.

Suggested Citation

Talley, Eric L. and Johnsen, Gudrun, Corporate Governance, Executive Compensation and Securities Litigation (May 4, 2004). Available at SSRN: or

Eric L. Talley (Contact Author)

Columbia University - School of Law ( email )

435 West 116th Street
New York, NY 10025
United States


European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Gudrun Johnsen

Danmarks Nationalbank ( email )

Havnegade 5
Copenhagen, 1093

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