Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 207: Financial structure, Managerial Compensation and Monitoring

Vittoria Cerasi () and Sonja Daltung ()
Additional contact information
Vittoria Cerasi: Statistics Department, Università degli Studi di Milano, Postal: Via Bicocca degli Arcimboldi 8, 20126 Milano, Italy
Sonja Daltung: Financial Institutions and Markets, Ministry of Finance, Financial Law and Economics Division, Postal: S-103 33 Stockholm, Sweden

Abstract: When a firm has external debt and monitoring by shareholders is essential, managerial bonuses are shown to be an optimal solution. A small managerial bonus linked to firm's performance not only reduces moral hazard between managers and shareholders, but also between creditors and monitoring shareholders. A negative relation between corporate bond yields and managerial bonuses can be predicted. Furthermore, the model shows how higher managerial pay-performance sensitivity goes hand in hand with greater company leverage and lower company diversification. These predictions find some support in the empirical literature.

Keywords: Keywords: Managerial Compensation; Financial Structure; Monitoring; Diversification.

JEL-codes: G32; M12

30 pages, June 1, 2007

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