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Does Pay Activism Pay Off for Shareholders?: Shareholder Democracy and its Discontents

Research output: Contribution to Journal/MagazineJournal articlepeer-review

<mark>Journal publication date</mark>1/04/2019
<mark>Journal</mark>Management Science
Issue number4
Number of pages23
Pages (from-to)1810-1832
Publication StatusPublished
Early online date26/10/17
<mark>Original language</mark>English


Typically, shareholders are not sure whether boards act in their interest or have been captured by management. They are also less well informed than boards about firm investment opportunities and operating conditions. We develop a model, consistent with these observations, in which discretionary compensation payments to managers might increase firm value or might simply enrich managers at the expense of shareholders. After observing the board’s compensation and investment policies, shareholders use Bayes’s rule to update the probability that the board is captured. Shareholders are “outraged” if this updated probability is sufficiently large. Outrage is costly for the board. Shareholder democracy, by enabling outrage to constrain board actions, typically lowers firm value relative to either governance regimes that insulate boards from shareholder outrage or regimes that ban discretionary compensation altogether.

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Copyright © 2017, INFORMS