We examine, both theoretically and empirically, top-management compensation in the presence of agency conflicts when shareholders have delegated governance responsibilities to a self-interested Board of Directors (BOD). We develop a theoretical framework that explicitly incorporates the BOD as a strategic player, models the negotiation process between the CEO and the BOD in designing CEO compensation, and considers the impact of potential takeovers by large shareholders monitoring the CEO-BOD negotiations. In equilibrium, internal governance by the BOD and external takeover threats by a large shareholder act as substitutes in imposing managerial control, especially in constraining management's profligacy in awarding equity-based compensation to itself. The model emphasizes factors in the design of compensation contracts that are rarely considered in the literature, such as equity ownership of the largest outside shareholder and the firm's bankruptcy risk. It also provides new perspectives on factors that are often considered in the literature, such as firm size, firm performance, equity ownership of the BOD, and BOD structure. Our empirical tests lend considerable support for our theoretical predictions. Equity ownership of the largest external shareholder, that of the BOD, and the default risk, are strongly negatively related to the size of CEO equity compensation. Consistent with the theoretical model, these factors do not significantly influence the growth of fixed (or non-performance-related) compensation. We also find that the equity ownership of the BOD is more important in managerial compensation control than other BOD related variables, such as BOD size or the proportion of outside directors.Corporate Governance and Board of Directors, Takeover Threats, Stock Options and CEO Compensation, Default Risk

Building on the managerial entrenchment literature, we develop and test a novel perspective on payout policy that integrates the influence of internal governance mechanisms, investment opportunities, management compensation, and monitoring by large shareholders. Our study incorporates both dividend payments and share repurchases, and examines the determinants of the likelihood and the level of payouts. Our model performs well in both in-sample and out-of-sample predictions on a sample of 2,081 firms during 1992–2000. We find that both the likelihood and the level of payouts are significantly and positively (negatively) related to factors that increase (decrease) executive entrenchment levels, even when controlling for size, leverage, and the proportion of tangible to total assets. We identify factors that significantly affect the likelihood but not the level of payouts (or vice versa), and show that entrenchment has an asymmetric influence on dividend vs. shares repurchase policy.

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