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On the Objective of Corporate Boards: Theory and Evidence

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  • Illoong Kwon
  • Katherine Guthrie
  • Jan Sokolowsky

Abstract

Abstract: There are two views on board objectives: (i) boards act as monitors with the objective to maximize firms' long-term fundamental values; and (ii) boards act myopically with a focus on firms' short-term market values. We propose a principal-agent model linking CEO incentive pay to earnings overstatement that allows us to differentiate between these objectives empirically. In response to an increase in the cost of overstating earnings, the model predicts an increase in CEO incentives if boards act as monitors, but a decrease in CEO incentives if boards are myopic. We find strong evidence of a decrease in CEO incentives around the Sarbanes-Oxley Act of 2002. Moreover, the model predicts that capital market pressure makes boards more myopic. We document a positive relationship between capital market pressure and CEO incentives. Around SOX, CEO incentives also fall by more in firms with high capital market pressure, as predicted by the model. Our results strongly support the myopic board view.

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Bibliographic Info

Paper provided by University at Albany, SUNY, Department of Economics in its series Discussion Papers with number 08-08.

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Date of creation: 2008
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Handle: RePEc:nya:albaec:08-08

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Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
Phone: (518) 442-4735
Fax: (518) 442-4736

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Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
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Web: http://www.albany.edu/economics/research/workingp/index.shtml

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Cited by:
  1. Kwon, Illoong & Yeo, Eunjung, 2009. "Overstatement and rational market expectation," Economics Letters, Elsevier, Elsevier, vol. 104(1), pages 9-12, July.

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