Managerial Incentives, Monitoring, and Risk Bearing: A Study of Executive Compensation, Ownership, and Board Structure in Initial Public Offerings

Abstract

Both authors contributed equally to the paper. The comments of Sanjai Bhagat, Jeanne Brett, Jerry Davis, Ron Dye, Peter Easton, Eugene Fama, John Hand, Steven Kaplan, Joe Moag, Jay Ritter, Abbie Smith, Robert Vishny, and three anonymous ASQ reviewers are greatly appreciated. Todd Glass and Jeffery Nguyen provided valuable research assistance. An earlier version of this paper received the Best Paper Award of the Business Policy and Strategy Division of the Academy of Management. We argue in this study that a resolution of the ambiguity and conflict surrounding executive compensation and corporate control practices requires a more unified perspective on top management compensation, ownership, and corporate governance. Drawing from agency and organizational research, the study develops and tests a contingency perspective on how organizations seek to ensure appropriate managerial behavior through a balancing of trade-offs between incentive, monitoring, and risk-bearing arrangements. We suggest that (1) the ability of firms to use executive compensation contracts to address managerial incentive problems is hampered by risk-bearing concerns that stem from the risk aversion of top managers, (2) this problem is particularly severe for riskier firms, and (3) firms seek to address this problem by structuring their boards of directors to ensure sufficient monitoring of managerial behavior, given the magnitude of the agency problem. This contingency perspective is then tested using a large sample of initial public offering firms. The findings and their implications for the debates about ownership and control and executive pay for performance are discussed.'