STEFFEN H. BRENNER, Humboldt University of Berlin - School of Business and Economics
Email: brenner@wiwi.hu-berlin.de
JOACHIM SCHWALBACH, Humboldt University of Berlin - Faculty of Business
Email: schwal@wiwi.hu-berlin.de

We examine whether anti-director laws and legal director liability rules matter for whether directors act diligently in setting the compensation of CEOs. The study uses a world-wide data set covering 27 countries for the period 1995 to 2005. Controlling for a number of legal and economic determinants, we find that independent of managerial risk-aversion, CEO pay is always less generous under stricter anti-director rules and a stronger rule of law. Director liability rules are associated with more generous pay schemes. The results persist once we control for the presence of institutional investors and cross-listing in the U.S.

We interpret our findings in the sense that anti-director right make boards more accountable to shareholders. As a consequence, directors tend to act more diligently when negotiating the pay contract with the CEO. Previous research identified lower economic performance of firms from civil law countries. Our study suggests that the presence of less diligent boards in these countries may contribute to this result. Moreover, our findings indicate that governmental anti-director rules are not completely substitutable by private measures of governance.

ROB BAUER, University of Maastricht - Limburg Institute of Financial Economics (LIFE)
Email: R.BAUER@BERFIN.UNIMAAS.NL
ROBIN BRAUN, University of Maastricht - Limburg Institute of Financial Economics (LIFE)
Email: r.braun@finance.unimaas.nl
FRANK MOERS, Maastricht University - Department of Accounting and Information Management, European Centre for Corporate Engagement (ECCE)
Email: f.moers@aim.unimaas.nl

We investigate whether equity-based incentives induce CEOs to take risks, which triggers dissident shareholders to sue the firm. We hypothesize that too strong incentives do not align the CEO with the firm but create perverse implications. In our paper corporate governance is a driver of variable CEO compensation levels and these incentives can trigger a propensity for fraud and stock price manipulation. We take shareholder-initiated class-action lawsuits as a proxy for discontent shareholders while focusing on the downside of equity-based incentives. We treat these as an inducement for the manager to manipulate earnings and stock prices. We empirically test, what determines CEOs' equity-based incentives and whether managers are able to set their own pay. We find that large and growth firms with stellar operating performance are more likely to become subject to a class-action lawsuit. We document significant shareholder wealth destruction by being accused of securities law violation and also find differ-ences between the types of allegations. We verify several corporate governance mechanisms and especially strong equity-based incentives increasing the likelihood of being sued. Corporate governance has a significant incremental explanatory power for determining CEO equity-based incentives. We obtain significantly positive effects for the option incentive component on the probability of alleged of securities law violation. Our findings suggest a potential warning to incentivize managers too much with stock options and we recommend a more conservative mix with inside debt incentives.

YANIV GRINSTEIN, Cornell University - Samuel Curtis Johnson Graduate School of Management
Email: yg33@cornell.edu
DAVID WEINBAUM, Cornell University - Samuel Curtis Johnson Graduate School of Management
Email: dw85@cornell.edu
NIR YEHUDA, Cornell University - Samuel Curtis Johnson Graduate School of Management
Email: ny35@cornell.edu

In December 2006, the new Securities and Exchange Commission rule requiring enhanced disclosure of perquisites to managers in public U.S. firms went into effect. We use this ruling to shed light on the role of perquisites in executive compensation. In a sample of 361 public firms that were subject to the rule, we find that firms responded to the rule by disclosing larger amounts of perks. The increase is significant in firms that are smaller, have larger amounts of free cash flow, and fewer growth opportunities. The market reacted negatively to the announcement of these perks in small firms, and in small firms which disclosed larger amounts of perks than before. Our results are in line with the argument that perks are an excess that reduces shareholder value.

INDRARINI LAKSMANA, Kent State University - Department of Accounting
Email: ilaksman@kent.edu

This study examines whether certain board and compensation committee characteristics, as proxies for board governance quality, are associated with the extent of board disclosure of executive compensation practices. A unique feature of this study is the development of a disclosure index using 23 compensation-related disclosures. I validate this index by showing that the disclosure scores are inversely related to two measures of information asymmetry: bid-ask spread and return volatility. This provides evidence that greater compensation disclosure reduces information asymmetry. The study presents some evidence that boards with the power to act independently from management provide more disclosure. In addition, it contributes to the literature on corporate governance and disclosure by showing that board disclosure increases with the amount of time and resources dedicated to board (compensation committee) duties. More specifically, boards with lower meeting frequency and those with fewer directors serving on them are associated with less transparency of compensation practices.

MARTIN J. CONYON, ESSEC Business School, University of Pennsylvania - The Wharton School, European Corporate Governance Institute (ECGI)
Email: martin.conyon@gmail.com

Executive compensation consultants are studied using data from the United States and the United Kingdom. The results show that the market for executive compensation services is characterized by few consultants who supply professional services to a large number of client firms. The market is concentrated. Consultants also supply other professional services to client firms (e.g. pension advice) raising potential concerns about conflicts of interest and consultant independence. It is also found that some firms use more than one compensation consultant, especially in the UK. Finally, the results show that the same major consultants (e.g. Frederick Cook, Towers Perrin) operate in the US and the UK.

GAVIN SMITH, University of New South Wales - School of Banking and Finance
Email: gavinsmith@student.unsw.edu.au
PETER L. SWAN, UNSW
Email: peter.swan@unsw.edu.au

The present study provides simple tests of both agency and monitoring theory. In doing so it builds on the pioneering contribution of Hartzell and Starks (2003) (HS). Consistent with agency theory, we find that concentrated institutional investing is associated with higher executive compensation. Moreover, we bring into question monitoring theory reliant on concentrated monitors. Concentrated institutional ownership appears unrelated to option grant pay-for-performance (PPS) sensitivity. We reconcile our differences with HS by the indicating the importance of a methodology that does not exaggerate the role of firm size and use of robust firm size controls.

EFRAIM BENMELECH, Harvard University - Department of Economics, National Bureau of Economic Research (NBER)
Email: effi_benmelech@harvard.edu
EUGENE KANDEL, Hebrew University of Jerusalem - Department of Economics, Centre for Economic Policy Research (CEPR)
Email: mskandel@mscc.huji.ac.il
PIETRO VERONESI, University of Chicago - Graduate School of Business, Centre for Economic Policy Research (CEPR), National Bureau of Economic Research (NBER)
Email: pietro.veronesi@gsb.uchicago.edu

Stock-based compensation is the standard solution to agency problems between shareholders and managers. In a dynamic rational expectations equilibrium model with asymmetric information we show that although stock-based compensation causes managers to work harder, it also induces them to hide any worsening of the firm's investment opportunities by following largely sub-optimal investment policies. This problem is especially severe for growth firms, whose stock prices then become over-valued while managers hide the bad news to shareholders. We find that a firm-specific compensation package based on both stock and earnings performance instead induces a combination of high effort, truth revelation and optimal investments. The model produces numerous predictions that are consistent with the empirical evidence.