Corporate Governance and Incentive Contracts: Historical Evidence from a Legal Reform

Abstract

This paper proposes to exploit a reform in legal rules of corporate governance to identify contractual incentives from the correlation of executive pay and firm performance. In particular, we refer to a major shift in the legal and institutional environment, the reform of the German joint-stock companies act in 1884. We analyze a sample of executive pay for 46 firms for the years 1870 to 1911. In 1884, a law reform substantially enhanced corporate control, strengthened the monitoring incentives of shareholders, and reduced the discretionary power of executives in Germany. Pay-performance sensitivity decreased significantly after this reform. While executives received a bonus of about three to five per cent in profits before 1884, after the reform this parameter decreased to a profit share of about two per cent. At least the profit share that is eliminated by the reform must have been incentive pay before. This incentive mechanism was replaced by other elements of corporate governance. JEL-Classification: G30, J33, N23

Information Disclosure and Corporate Governance

“…In fact, this pattern holds not only in recent U.S. data: Bayer and Burhop (2009) find that German bank executives became more vulnerable to dismissal after a major reform in 1884, which increased reporting requirements. In addition, Bayer and Burhop (2007) find that executive compensation also increased following that 19 th ‐century reform.…”

Extreme divorce: the managerial revolution in UK companies before 19141

“…101 101 Campbell and Turner, ‘Substitutes’; Bayer and Burhop, ‘Corporate governance’; Bloom and van Reenen, ‘Measuring and explaining’; J. Foreman‐Peck, and L. Hannah, ‘Corporate governance’, paper delivered to Eurhistock conference, Judge Business School, Cambridge (8 April 2010). …”

Information technology, an enabler in corporate governance

“…Of particular importance to this the study is two main aspects: incentives provided to corporate executives; and how information technology can be utilized as a driver of incentives in the decision making process of corporate governance. Providing the right incentives to corporate executives is an important facet that drives corporate governance, and of is of great concern to shareholders (Bayer and Burhop, 2008). Sun Tzu, the famous Chinese general said ''The quality of a decision is like the well-timed swoop of a falcon which enables it to strike and kill its victims'' (Sun Tzu, n.d.).…”