Executive Compensation and the Role for Corporate Governance Regulation

This paper establishes a role for corporate governance regulation. An externality operating through executive compensation motivates regulation. Governance lowers agency costs, allowing firms to grant less incentive pay. When a firm increases governance and lowers incentive pay, other firms can also lower executive compensation. Because firms do not fully internalize the benefit of governance, regulation can improve investor welfare. When regulation is enforced, large firms increase in value, small firms decrease in value, and all firms lower incentive pay. Distinct cross-sectional and cross-industry predictions for the number of voluntary governance firms are provided