A dynamic model of managerial entrenchment and the positive incentives it creates

Graeme Guthrie

Journal of Economic Dynamics and Control, 2021, vol. 123, issue C

Abstract: This paper presents a real-options model of entrenchment in which a CEO chooses how much effort to put into boosting a firm’s productivity and the board and CEO bargain over executive-compensation and investment policies. The surplus that bargaining allocates derives from the reduction in value of the firm’s capital that occurs if the CEO is replaced. Even if the CEO has no ownership stake, she exerts effort in order to increase the value of the capital at risk. This increases the shared surplus, which increases the CEO’s current pay. Newly appointed CEOs are paid less and work harder than their entrenched counterparts. They exert more effort at firms where the CEO’s human capital is more important. In contrast, entrenched CEOs exert more effort at firms where their human capital is less important and turnover-induced disruption has a higher cost. Both types work harder when average productivity growth is higher and productivity growth is more sensitive to effort. The board and CEO will agree to accept a degree of investment inefficiency if this allows them to slow down the CEO’s entrenchment.

Keywords: Corporate governance; Entrenchment; Executive compensation; Nash bargaining solution; Ownership-based incentives (search for similar items in EconPapers)
JEL-codes: C78 D25 G34 G35 M12 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:123:y:2021:i:c:s0165188920302256

DOI: 10.1016/j.jedc.2020.104057

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