Publication: Essays on the economic theory of managerial incentives
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2007-07
Defense date
2007-12-19
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Abstract
Corporations are very common in the business world. In this kind of organizations
shareholders are protected by limited liability and, furthermore, they can easily transfer
their shares. As a consequence, investors might be interested in buying a corporation's
shares just to diversify their portfolios, without any real interest in getting involved in
management. It is therefore much easier for corporations to obtain external finance than
other organizational forms, and this might well be the basic reason for their wide diffusion.
For the very same reason, however, it is necessary to hire professional managers to make
all the relevant decisions, and this contains the seed of their problematic governance. In
fact, the separation of ownership and control produces a conflict of interest between shareholders,
interested in maximizing the firm value, and managers, who can be interested in
pursuing a variety of different objectives (empire building, entrenchment, shirking, etc.).
This dissertation is composed by three research papers dealing with the economics
of managerial incentive provision. It is common to interpret the relationship between
shareholders and managers as an agency relationship affected by both a moral hazard
and adverse selection problem. Usually, managerial incentives are affected by several
elements such as, for example, their compensation packages and career concerns, the
internal monitoring of the board of directors, the external monitoring of the market for
corporate control, etc. This dissertation suggests that it might be necessary to consider
Overview 2
the interactions between alternative incentive mechanisms both to better understand their
functioning and, at least as importantly, to help interpreting empirical observations.
The first chapter, Paying for Observable Luck, proposes a simple hidden action model
which explains recent empirical evidence of asymmetric benchmarking in managerial compensation:
managers appear to be insulated from bad luck but not from good luck. The
explanation hinges on the interaction between explicit contractual incentives and implicit
incentives deriving from the possibility of bankruptcy. The second chapter, Career
Concerns and Competitive Pressure, studies how the level of competition in the product
market a ects the strength of managerial career concerns. Good managers are in short
supply so that firms are willing to compete for them. However, the value of good managers
depends on the profit differential they are able to produce on the product market.
It is then shown that increased competition makes career concerns stronger if it increases
such profit differential. The third chapter, Managerial Entrenchment and the Market
for CEOs, suggests that the observed trends of increased managerial pay and increased
board independence might be related. Boards captured by an entrenched managers are
not active on the demand side of the managerial labor market. Therefore, increased
board independence, reducing the number of captured boards, also increases competition
for good managers, then rising their pay and making their career concerns stronger.
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Keywords
Personal directivo, Incentivos económicos, Teoría económica