A greater threat of takeover has two opposing effects on managerial compensation. The competition effect in the market for managers reduces compensation. The risk effect increases compensation by making managers' implicitly deferred compensation and firm-specific human capital less secure.

The threat of takeover acts to discipline managers, but it also makes shareholders' assurances to managers less reliable and so interferes with contrcting between them. These two effects have opposing implications about the level of executive compensation: the disciplinary effect implies a...