The Complementary Roles of Board Incentives and Market Monitoring : Theory and Evidence

In this paper I rectify the market governance model of Holmstrom and Tirole (1993) to develop and test a number of hypotheses concerning company board structure and incentives. Exogeneity stems from the forced departure of "non-independent" directors with substantial shareholdings from boards due to regulatory-induced pressure. Various market and accounting measures of performance, investment decision-making with respect to acquisitions, and negotiation and monitoring of CEO and non-executive director pay substantially worsen in the presence of this external market monitoring. I conclude that informed traders utilize information about the actions of board members that reinforce market-based incentives