Abstract
The paper examines costs and benefits of managerial diversion along with monitoring costs to control diversion and incentive costs to substiture for diversion. The paper finds that managers will put out more effort when they are allowed to divert firm resources. Managerial diversion may exist in the equilibrium. In particular, when regulation is loose, or monitoring is inefficient, or managerial discretion is high, allowing managerial diversion is a less costly second best choice for shareholders than imposing a diversion-free governance design. Finally, the paper shows that managerial types influence the magnitude of diversion and the effectiveness of control mechanisms. There is no best way of governance mechanisms for all types of managers.
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