DP15625 The Complementarity between Signal Informativeness and Monitoring

Author(s): Pierre Chaigneau, Nicolas Sahuguet
Publication Date: January 2021
Keyword(s): board monitoring, corporate governance system, governance complementarity, hard and soft information
JEL(s):
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15625

When assessing managerial ability, a firm can rely on two sources of information: a signal of firm value, such as earnings, and monitoring. We show that a more informative signal can surprisingly increase the value of monitoring. This happens if a more informative signal makes some signal realizations more ambiguous indicators of managerial ability, or if the signal leads to negative belief updating on managerial ability yet does not trigger termination. Then, termination decisions will paradoxically rely less on the signal when it is more informative. In private equity owned firms, the model predicts that monitoring intensity is increasing in signal informativeness conditional on a bad performance. These firms can fall into a "bad governance trap" such that a less informative signal is compounded by worse monitoring upon a bad performance.