Working Paper: CEPR ID: DP2391
Authors: Andres Almazan; Javier Suarez
Abstract: 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.
Keywords: corporate governance; board of directors; severance pay; takeovers
JEL Codes: G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| CEO control (M12) | CEO negotiation power (M12) |
| CEO negotiation power (M12) | higher severance pay (J65) |
| board structure (Y10) | CEO compensation dynamics (M12) |
| independent boards (L39) | time-inconsistency problem (D15) |
| time-inconsistency problem (D15) | replacement decisions (C52) |
| CEO-controlled boards (G34) | entrenchment risk (G32) |
| CEO-controlled boards (G34) | optimal arrangement under certain conditions (H21) |
| severance pay (J65) | mitigate time-inconsistency in independent boards (G34) |
| severance pay (J65) | reduce CEO resistance to replacement in CEO-controlled boards (G34) |