Performance-Based Incentives for Internal Monitors

David Larcker is the James Irvin Miller Professor of Accounting at Stanford University.

In the paper, Performance-Based Incentives for Internal Monitors, which was recently published on SSRN, my co-authors (Christopher Armstrong and Alan Jagolinzer) and I investigate the choice of performance-based incentives for the general counsel (GC) and chief internal auditor (IA) and assess whether these incentives enhance or impair monitoring.

We use proprietary and public data that provide details about the incentive-compensation contracts of the GC and the IA to identify the determinants of performance-based incentives of internal monitors. More importantly, we also examine the impact these incentives have on either alleviating or exacerbating agency problems within the firm. We draw inferences regarding the implications of compensating internal monitors with performance-based incentives using a propensity score matched-pair research design, which helps address econometric concerns related to the endogenous design of compensation contracts.

We find that internal monitors receive greater incentives when their job duties contribute more to the firm’s production function. Internal monitors also receive greater incentives when they are more highly ranked within the firm and when the firm’s CEO receives greater incentives, consistent with standardization in compensation contracts within the executive suite. In addition, monitors receive lower incentives at firms with greater ex ante litigation risk, consistent with risk-averse monitors demanding less risky compensation when their human capital is more at risk. Finally, we find some evidence that incentive levels are greater when there is more demand for internal monitoring.

To better understand the implications of internal monitor incentives, we examine the association between internal monitor incentive levels and the frequency of adverse firm outcomes, which we use to proxy for unresolved agency problems within the firm. After matching monitors on observable characteristics of their contracting environments using a propensity score approach, we find a lower frequency of adverse outcomes (e.g., regulatory enforcement actions and internal-control material-weakness disclosures) at firms that provide their monitors with greater performance-based incentives. These results are consistent across a variety of alternative measures of incentives and outcomes and appear to be generally robust to omitted variable bias.

Overall, our results support the notion that performance-based incentives enhance the internal monitoring function, perhaps by providing incentives for better monitoring efforts or by facilitating the selection of more talented monitors. These results may allay concerns raised in the economics and legal literatures regarding whether performance-based incentives are an appropriate form of compensation for internal monitors. These results also provide new insights into the implications of providing management with incentive-based compensation by focusing directly on the implications of providing incentives to corporate officers who are responsible for overall governance within the firm.

The full paper is available for download here.

Other posts about: , , ,
Other posts from:
Post a comment or leave a trackback: Trackback URL.

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

  • Subscribe

  • Cosponsored By:

  • Supported By:

  • Programs Faculty & Senior Fellows

    Lucian Bebchuk
    Alon Brav
    Robert Charles Clark
    John Coates
    Alma Cohen
    Stephen M. Davis
    Allen Ferrell
    Jesse Fried
    Oliver Hart
    Ben W. Heineman, Jr.
    Scott Hirst
    Howell Jackson
    Wei Jiang
    Reinier Kraakman
    Robert Pozen
    Mark Ramseyer
    Mark Roe
    Robert Sitkoff
    Holger Spamann
    Guhan Subramanian

  • Program on Corporate Governance Advisory Board

    William Ackman
    Peter Atkins
    Joseph Bachelder
    John Bader
    Allison Bennington
    Richard Breeden
    Daniel Burch
    Richard Climan
    Jesse Cohn
    Isaac Corré
    Scott Davis
    John Finley
    Daniel Fischel
    Stephen Fraidin
    Byron Georgiou
    Larry Hamdan
    Carl Icahn
    David Millstone
    Theodore Mirvis
    James Morphy
    Toby Myerson
    Barry Rosenstein
    Paul Rowe
    Rodman Ward