HEADS I WIN, TAILS YOU LOSE: INSTITUTIONAL MONITORING OF EXECUTIVE PAY RIGIDITY

Abstract

Agency theory argues that pay for performance alleviates the conflict of interest between managers and shareholders. Furthermore, the literature finds that institutional monitoring tends to promote the performance–pay linkage, thus aligning the two parties’ incentives. We find that executive compensation rigidity is negatively and significantly associated with firm value. Moreover, ownership by long‐term institutional investors reduces the pay rigidity of top managers in underperforming firms, thus decreasing the value‐destroying effect of the rigidity. Overall, these results reaffirm the role of institutional monitoring in mitigating managerial rent extraction.