Keeping the Board in the Dark: CEO Compensation and Entrenchment

43 Pages Posted: 30 Dec 2005

See all articles by Roman Inderst

Roman Inderst

Goethe University Frankfurt

Holger M. Mueller

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 3 versions of this paper

Date Written: October 2005

Abstract

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 vis-a-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.

Keywords: CEO compensation, entrenchment, severance pay, stock options

JEL Classification: G3

Suggested Citation

Inderst, Roman and Mueller, Holger M., Keeping the Board in the Dark: CEO Compensation and Entrenchment (October 2005). CEPR Discussion Paper No. 5315, Available at SSRN: https://ssrn.com/abstract=872872

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

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HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

Holger M. Mueller

New York University (NYU) - Department of Finance ( email )

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HOME PAGE: http://www.stern.nyu.edu/~hmueller/

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR)

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European Corporate Governance Institute (ECGI) ( email )

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1000 Brussels
Belgium

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