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

Posted: 2 Jul 2008

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

Date Written: May 2008

Abstract

Recent corporate governance reforms focus on the board's independence and encourage equity ownership by directors. We analyze the efficacy of these reforms in a model in which 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: G31, G34, D82

Suggested Citation

Kumar, Praveen and Sivaramakrishnan, Shiva, Who Monitors the Monitor? The Effect of Board Independence on Executive Compensation and Firm Value (May 2008). The Review of Financial Studies, Vol. 21, Issue 3, pp. 1371-1401, 2008, Available at SSRN: https://ssrn.com/abstract=1154429 or http://dx.doi.org/hhn010

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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