Executive Compensation and Investor Clientele

47 Pages Posted: 13 Oct 2006

See all articles by Laura Frieder

Laura Frieder

Purdue University - Krannert School of Management

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Date Written: October 2006

Abstract

Executive compensation has increased dramatically in recent times, but so has trading volume and individual investor access to financial markets. We provide a model in which some managers obfuscate financial statements in order to extract additional compensation. Owing to a lack of sophistication or naivete, possibly arising from high opportunity costs of learning about accounting conventions and financial markets, small investors do not ascertain the extent of this behavior. Expected compensation is therefore higher when small investors form a more significant clientele in the market for a firm's stock. Our model further suggests that increased information asymmetry between large and small traders may deter the entry of small investors and keep executive compensation in check. Technologies that lower the cost of trading facilitate entry of small investors and raise expected compensation. Such compensation can in general be reduced through appropriate regulation and transparent disclosures. Empirical tests provide support to the key implication of the model that indirect executive compensation is higher in stocks with more retail investor participation.

Keywords: executive compensation, corporate governance

JEL Classification: G14, G32, G34, J33, M41, M43, M45

Suggested Citation

Frieder, Laura and Subrahmanyam, Avanidhar, Executive Compensation and Investor Clientele (October 2006). Available at SSRN: https://ssrn.com/abstract=937115 or http://dx.doi.org/10.2139/ssrn.937115

Laura Frieder

Purdue University - Krannert School of Management ( email )

1310 Krannert Building
West Lafayette, IN 47907-1310
United States

Avanidhar Subrahmanyam (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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