Board of discord: Conflicting preferences and performance pay

Steven Schmeiser

Cogent Economics & Finance, 2023, vol. 11, issue 2, 2279871

Abstract: This study examines the interaction of conflicting preferences among directors, performance pay, and group effort. I model a corporate board in which directors voluntarily choose to research (or not research) an investment decision made by the board on behalf of the firm. Free-riding among directors creates a need for performance pay to motivate this costly research. The study shows that board diversity, modeled as heterogeneous personal preferences among directors over the chosen investment, can act as a substitute for costly performance pay and, in equilibrium, benefit the firm. This creates a direct financial incentive for firms to increase board diversity. The study then shows how the optimal level of diversity changes with board and firm characteristics and generates a set of testable empirical predictions.

Date: 2023
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DOI: 10.1080/23322039.2023.2279871

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