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Title: Performance Pay, CEO Dismissal, and the Dual Role of Takeovers

Author(s): Mike Burkart and Konrad Raff

Publication Date: February 2012

Keyword(s): Board Interference, CEO Turnover, Compensation and Takeover

Programme Area(s): Financial Economics

Abstract: We propose that an active takeover market provides incentives by offering acquisition opportunities to successful managers. This allows firms to reduce performance-based compensation and can rationalize loss-making acquisitions. At the same time, takeovers remain a substitute for board dismissal in the replacement of poorly performing managers. The joint impact of the two mechanisms on managerial turnover is, however, multi-faceted: In firms with strong boards, turnover and performance-based pay are non-monotonic in the intensity of the takeover threat. In firms with weak boards, turnover (performance-based pay) increases (decreases) with the intensity of the takeover threat. When choosing its acquisition policy and the quality of its board, each firm ignores the adverse effect on other firms' acquisition opportunities and takeover threat. As a result, the takeover market is not sufficiently liquid and too few takeovers occur.

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Bibliographic Reference

Burkart, M and Raff, K. 2012. 'Performance Pay, CEO Dismissal, and the Dual Role of Takeovers'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8794