The function of independent directors with different payoff rules: the issue of shareholder activism

Abstract

We discuss the function of independent directors with different payoff rules in situations where firms must fund by equity capital in an environment of corporate governance, and we examine the strategic choices of managers, auditors and independent directors. This paper applies game theory. The main results show that (a) the auditor and the independent director can raise the possibility of managers choosing beneficial projects; (b) corporate governance can induce managers to report honestly, and impel the independent director to maintain independence; (c) under fixed payoffs, the independent director can maintain independence more easily and (d) the independent director who maintains independence can solve information asymmetry problems. The analytical results imply that the effectiveness of independent directors is assisted in resolving agency problems, and the payoff rules of independent directors are problems that must be considered.