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Keeping the Board in the Dark: CEO Compensation and Entrenchment

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  • Inderst, Roman
  • Mueller, Holger

Abstract

We study a model in which a CEO can entrench himself by hiding information from the board that would allow the board to conclude that he should be replaced. Assuming that even diligent monitoring by the board cannot fully overcome the information asymmetry vis-Ã -vis the CEO, we ask if there is a role for CEO compensation to mitigate the inefficiency. Our analysis points to a novel argument for high-powered, non-linear CEO compensation such as bonus pay or stock options. By shifting the CEO?s compensation into states where the firm?s value is highest, a high-powered compensation scheme makes it as unattractive as possible for the CEO to entrench himself when he expects that the firm?s future value under his management and strategy is low. This, in turn, minimizes the severance pay needed to induce the CEO not to entrench himself, thereby minimizing the CEO?s informational rents. Amongst other things, our model suggests how deregulation and technological changes in the 1980s and 1990s might have contributed to the rise in CEO pay and turnover over the same period.

Suggested Citation

  • Inderst, Roman & Mueller, Holger, 2005. "Keeping the Board in the Dark: CEO Compensation and Entrenchment," CEPR Discussion Papers 5315, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:5315
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Yermack, David, 2006. "Golden handshakes: Separation pay for retired and dismissed CEOs," Journal of Accounting and Economics, Elsevier, vol. 41(3), pages 237-256, September.
    2. Xavier Gabaix & Augustin Landier, 2008. "Why has CEO Pay Increased So Much?," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(1), pages 49-100.
    3. Keiichi Hori & Hiroshi Osano, 2017. "Agency Contracts, Noncommitment Timing Strategies and Real Options," The Japanese Economic Review, Springer, vol. 68(4), pages 521-554, December.
    4. Matthias Kiefer & Edward Jones & Andrew Adams, 2016. "Principals, Agents and Incomplete Contracts: Are Surrender of Control and Renegotiation the Solution?," CFI Discussion Papers 1603, Centre for Finance and Investment, Heriot Watt University.
    5. Bazrafshan, Ebrahim & Marcus, Alan J. & Tehranian, Hassan, 2021. "CEOs versus the board: Implications of strained relations for stock liquidity," Global Finance Journal, Elsevier, vol. 48(C).
    6. repec:zbw:bofrdp:2014_002 is not listed on IDEAS
    7. repec:zbw:bofrdp:2015_005 is not listed on IDEAS
    8. Jokivuolle, Esa & Keppo, Jussi & Yuan, Xuchuan, 2015. "Bonus caps, deferrals and bankers' risk-taking," Bank of Finland Research Discussion Papers 5/2015, Bank of Finland.
    9. Jokivuolle, Esa & Keppo, Jussi, 2014. "Bankers' compensation: Sprint swimming in short bonus pools?," Bank of Finland Research Discussion Papers 2/2014, Bank of Finland.
    10. Jokivuolle, Esa & Keppo, Jussi & Yuan, Xuchuan, 2015. "Bonus caps, deferrals and bankers' risk-taking," Research Discussion Papers 5/2015, Bank of Finland.
    11. Jokivuolle, Esa & Keppo, Jussi, 2014. "Bankers' compensation: : Sprint swimming in short bonus pools?," Research Discussion Papers 2/2014, Bank of Finland.
    12. Benjamin E. Hermalin & Michael S. Weisbach, 2007. "Transparency and Corporate Governance," NBER Working Papers 12875, National Bureau of Economic Research, Inc.
    13. repec:bof:bofrdp:urn:nbn:fi:bof-201503041096 is not listed on IDEAS
    14. repec:zbw:bofrdp:urn:nbn:fi:bof-201503041096 is not listed on IDEAS
    15. Benjamin E. Hermalin & Michael S. Weisbach, 2006. "A Framework for Assessing Corporate Governance Reform," NBER Working Papers 12050, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    Ceo compensation; Entrenchment; Severance pay; Stock options;
    All these keywords.

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance

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