DP8936 Competition for Managers, Corporate Governance and Incentive Compensation

Author(s): Viral V. Acharya, Marc Gabarro, Paolo Volpin
Publication Date: April 2012
Keyword(s): corporate governance, executive compensation, externalities
JEL(s): D82, G18, G21
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8936

We propose a model in which better governance incentivizes managers to perform better and thus saves on the cost of providing pay for performance. However, when managerial talent is scarce, firms' competition to attract better managers reduces an individual firm's incentives to invest in corporate governance. In equilibrium, better managers end up at firms with weaker governance, and conversely, better-governed firms have lower-quality managers. Consistent with these implications, in a sample of US firms, we show that (i) better CEOs are matched to firms with weaker corporate governance and more so in industries with stronger competition for managers, and, (ii) corporate governance is more likely to change when there is CEO turnover, with governance weakening when the incoming CEO is better than the departing one.