Who Monitors the Monitor? The Effect of Board Independence on Executive Compensation and Firm Value

Posted: 11 Oct 2007

See all articles by Praveen Kumar

Praveen Kumar

University of Houston - Department of Finance

Shiva Sivaramakrishnan

Rice University

Multiple version iconThere are 3 versions of this paper

Abstract

Recent corporate governance reforms focus on board independence and encourage equity ownership by directors. We analyze the efficacy of these reforms in a model where both adverse selection and moral hazard exist at the level of the firm's management. Delegating governance to the board improves monitoring but creates another agency problem because directors themselves avoid effort and are dependent on the CEO. We show that as directors become less dependent on the CEO, their monitoring efficiency may decrease even as they improve the incentive-efficiency of executive compensation contracts. Therefore, a board composed of directors that are more independent may actually perform worse. Moreover, higher equity incentives for the board may increase equity-based compensation awards to management.

Keywords: Corporate governance, Board of directors, Monitoring, Director independence, Equity incentives, Executive compensation

JEL Classification: G31, G34, D82, J33

Suggested Citation

Kumar, Praveen and Sivaramakrishnan, Shiva, Who Monitors the Monitor? The Effect of Board Independence on Executive Compensation and Firm Value. Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1020677

Praveen Kumar (Contact Author)

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Shiva Sivaramakrishnan

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

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