Keeping the Board in the Dark: CEO Compensation and Entrenchment

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 visà- 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

CEO Turnover in a Competitive Assignment Framework

There is considerable and widespread concern about whether CEOs are appropriately punished for poor performance. The empirical literature on CEO turnover documents that CEOs are indeed more likely to be forced out if their performance is poor relative to the industry average. However, CEOs are also more likely to be replaced if the industry is doing badly. We show that these empirical patterns are natural and efficient outcomes of a competitive assignment model in which CEOs and firms form matches based on multiple characteristics, and where industry conditions affect the outside options of both managers and firms. Our model also has several new predictions about the type of replacement manager, and their pay and performance. We construct a dataset which describes all turnover events during the period 1992-2006 and show that these predictions are also born out empirically