No. 207 Financial structure, Managerial Compensation and Monitoring

by Vittoria Cerasi and Sonja Daltung

June 2007

Abstract

When a .rm has external debt and monitoring by shareholders is essential, managerial bonuses are shown to be an optimal solution. A small managerial bonus linked to .rm.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 diversi.cation. These predictions .nd some support in the empirical literature.

Keywords

Managerial Compensation; Financial Structure; Monitoring; Diversi.cation.

JEL classification

G320, M120