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A dynamic model of managerial entrenchment and the positive incentives it creates

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  • Guthrie, Graeme

Abstract

This paper presents a real-options model of entrenchment in which a CEO chooses how much effort to put into boosting a firm’s productivity and the board and CEO bargain over executive-compensation and investment policies. The surplus that bargaining allocates derives from the reduction in value of the firm’s capital that occurs if the CEO is replaced. Even if the CEO has no ownership stake, she exerts effort in order to increase the value of the capital at risk. This increases the shared surplus, which increases the CEO’s current pay. Newly appointed CEOs are paid less and work harder than their entrenched counterparts. They exert more effort at firms where the CEO’s human capital is more important. In contrast, entrenched CEOs exert more effort at firms where their human capital is less important and turnover-induced disruption has a higher cost. Both types work harder when average productivity growth is higher and productivity growth is more sensitive to effort. The board and CEO will agree to accept a degree of investment inefficiency if this allows them to slow down the CEO’s entrenchment.

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  • Guthrie, Graeme, 2021. "A dynamic model of managerial entrenchment and the positive incentives it creates," Journal of Economic Dynamics and Control, Elsevier, vol. 123(C).
    • Handle: RePEc:eee:dyncon:v:123:y:2021:i:c:s0165188920302256
    DOI: 10.1016/j.jedc.2020.104057
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    1. Xu, Jing, 2022. "Competition and equilibrium effort choice," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).

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    More about this item

    Keywords

    Corporate governance; Entrenchment; Executive compensation; Nash bargaining solution; Ownership-based incentives;
    All these keywords.

    JEL classification:

    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • D25 - Microeconomics - - Production and Organizations - - - Intertemporal Firm Choice: Investment, Capacity, and Financing
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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