Executive compensation internal monitoring CEO turnover and firm performance

Abstract

Corporate governance is a field in economics that investigates how to motivate efficient management of corporations by balancing between monitoring and incentive mechanisms, through contracts, organizational designs and legislation. Corporate governance mechanisms can be divided into two broad types: external mechanisms and internal mechanisms. External corporate governance mechanisms relate to takeovers and product market competition, law and public practices. Internal corporate governance mechanisms relate to monitoring by shareholders, monitoring by the board of directors, executive compensation, and hiring and firing of the CEO and other executive directors. newlineThe dominant academic view on the issue of board structure, executive compensation and firm performance essentially draws on the theory of agency costs. Such costs arise due to the separation of ownership and control in widely held corporations. One way to mitigate the agency problem is to align the incentive of the CEO with those of the shareholders. Another alternative way for the shareholders is to appoint the board of directors to monitor the managers. Of course, the board can be entrusted to find ways to incentivize the managers to work in the interest of the shareholders. The board is the link between shareholders and managers. It is the fiduciary responsibility of the board to oversee the management on behalf of the shareholders. newlineWith the ushering economic liberalization in recent years, different corporate governance committees have been set up to reform the governance systems in emerging economies like India, South Africa, China. These committees highlighted the importance of optimal designing of board structures, information disclosure and executive compensation to ameliorate agency problems and positively influence firm performance. newlineChapter 2 examines the effect of board structure and board compensation on firm performance. However, since firm performance itself might influence board compensation there is an issue of endogeniety. So, we use