Say on Pay and the 'Quiet Life' of Boards

Abstract

The rapid rise in CEO pay over the past decades has fueled an intensive debate on corporate governance. Fiduciary duty rules are supposed to safeguard shareholders' interests when boards design compensation packages for managers. However the so-called power view holds that boards may be colluding with CEOs to transfer wealth from shareholders. In response, recent regulatory initiatives such as Say on Pay and the Dodd-Frank Act aim to reinvigorate fiduciary duty rules and to put shareholders back in control. I develop a model in which a self-interested board contracts with a CEO in a setting that combines agency frictions and strategic communication. The board can learn about the firm's environment through monitoring and/or communication. In equilibrium, the board has an excessive preference for communication. As a result, the board grants the CEO a greater equity stake than as preferred by the shareholders. While this may seem consistent with the managerial power view, it is in fact more a manifestation of the board pursuing a quiet life, because the greater CEO equity stake promotes CEO-board communication, and thereby reduces the pressure for the board to engage in costly monitoring. By adjusting the board's equity stake, the shareholders can actively preempt such behavior, though they may not always choose to do so. Ironically, I find that precisely for those cases where the board successfully subverts the shareholders' intent, the board is ultimately worse off from having discretion. This illustrates the importance of taking boards as strategic, self-interested players, rather than assuming they align themselves fully with either shareholders or management.