Optimal Contracting with Costly State Verification, with an Application to Crowdsourcing*

This study uses a sample of IPO firms to investigate the relation between the compensation committee, CEO compensation, and CEO incentives. We investigate two theoretical models: the three-tier optimal contracting model and the managerial power model. We find support for the three-tier agency model. The presence of significant shareholders on the compensation committee (i.e., those with share stakes in excess of 5 percent) is associated with lower CEO pay and higher CEO equity incentives. Firms with higher paid compensation committee members are associated with greater CEO compensation and lower incentives. The managerial power model receives little support. We find no evidence that insiders or CEOs of other firms serving on the compensation committee raise the level of CEO pay or lower CEO incentives.

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Biased Boards

The Accounting Review ◽

10.2308/accr-52210 ◽

2018 ◽

Vol 94 (2) ◽

pp. 1-27 ◽

Cited By ~ 4

Author(s):

Tim Baldenius ◽

Xiaojing Meng ◽

Lin Qiu

Keyword(s):

Cheap Talk ◽

Relevant Information ◽

Information Gathering ◽

Corporate Board ◽

Rent Extraction ◽

Initial Information ◽

Precise Information ◽

Optimal Contracting ◽

Information Advantage ◽

Empirical Regularity

ABSTRACT We study a corporate board tasked with monitoring a firm's CEO and providing incrementally decision-relevant information. The board has both compensation and non-pecuniary incentives—we label the latter board bias. Friendly boards have muted information gathering incentives, but can more effectively engage in cheap talk communication with management. As a result, the direction of the optimal board bias is determined by the CEO's initial information advantage: the board should be weakly friendly if the CEO is endowed with precise information, and weakly antagonistic (to the CEO) otherwise. Aside from assembling a friendly board, another way for shareholders to foster CEO/board communication is by granting the CEO more equity. In general, we find board friendliness and CEO equity grants to be positively associated, in equilibrium. This provides an optimal contracting rationale for an empirical regularity often interpreted as friendly boards facilitating rent extraction.

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