DP2391 Optimal Corporate Governance Structures

Author(s): Andres Almazan, Javier Suarez
Publication Date: February 2000
Keyword(s): Board Of Directors, Corporate Governance, Severance Payment, Takeovers
JEL(s): G34
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2391

This paper explores how motivating an incumbent CEO to make investments that improve the effectiveness of the firm organization under his management interacts with the replacement policy of the board of directors. We characterize the optimal compensation package (including severance pay) under governance structures that differ in the power that the incumbent CEO has on the board of directors. We explain why yielding the incumbent CEO some control of the board (entrenchment) can be desirable and offer predictions on when this arrangement is optimal. We also examine the correlation between the elements of his compensation package and the structure of the board.