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Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

by Laux, Volker

in Accounting / Ambiguity / Applied sciences / Bilanzpolitik / Board of directors / board oversight / Boards of directors / Business operations / Business risks / Business structures / CEO incentive pay / Chief executive officers / Chief executives / Compensation / Compensation and benefits / Compensation management / Corporate Governance / director liability / Earnings management / Effects / Employees / Equilibrium / Exact sciences and technology / Executive compensation / Executives / Financial liabilities / Financial reporting / Fines & penalties / Firm modelling / Incentive pay / Incentives / Liability / Litigation / Managervergütung / Manipulation / Methods / Operational research and scientific management / Operational research. Management science / Outside directors / Pay / Pay for performance / Personal liability / Professional liability / Risk / Settlements & damages / Shareholder value / Shareholders / Stockholders / Studies / USA / Wirtschaftskriminalität / Wirtschaftsprüfung

2010

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Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

by Laux, Volker

2010

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Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

by Laux, Volker

2010

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Journal Article

Effects of Litigation Risk on Board Oversight and CEO Incentive Pay

Laux, Volker

2010

Overview

Various commentators have praised the WorldCom and Enron settlements for holding outside directors personally liable, arguing that heightened director liability will induce greater board oversight. This paper shows that the connection between director liability and board behavior is more subtle, because directors have multiple means to respond to an increase in liability exposure: They can increase oversight to prevent accounting manipulation and/or reduce performance-based CEO pay to mitigate the CEO's ex ante incentive to engage in manipulation. These two decisions are interrelated, implying that the effects of director liability on board oversight and CEO incentive pay are ambiguous. In particular, the model predicts that, for firms in which board oversight is difficult and costly (e.g., large firms with complex business operations), a stricter legal environment for directors leads to a lower level of board oversight, lower CEO incentive pay, and lower shareholder value.

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Publisher

INFORMS,Institute for Operations Research and the Management Sciences

Subject

/ Boards of directors