Working Paper: CEPR ID: DP5818
Authors: Rui Albuquerque; Jianjun Miao
Abstract: This paper presents a contracting model of governance based on the premise that CEOs are the main promoters of governance change. CEOs use their power to extract higher pay or private benefits, and different governance structures are preferred by different CEOs as they favour one or the other type of compensation. The model explains why good countrywide investor protection breeds good firm governance and predicts a 'race to the top' in firm-governance quality after the Sarbanes-Oxley Act. However, such governance changes may be associated with higher rather than lower CEO pay as CEOs substitute away from private benefits. The model also provides an explanation for the observed correlation of CEO pay and firm governance based on CEO power. Finally, we discuss the optimality of introducing randomness in CEO hiring, for example, by evaluating CEOs based on qualitative characteristics, or soft skills, that are prone to diverse judgements.
Keywords: CEO compensation; CEO power; Investor protection; Moral hazard
JEL Codes: G34; J33; K00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| External governance (G38) | Internal governance (G38) |
| Sarbanes-Oxley Act (G38) | Internal governance (G38) |
| External governance (G38) | CEO pay (M12) |
| CEO power (M12) | CEO compensation (M12) |
| CEO power (M12) | governance practices (G38) |
| CEO risk aversion (D81) | CEO compensation (M12) |
| CEO power changes (G34) | governance quality (H11) |
| Randomness in CEO hiring (D79) | governance changes (G38) |