THE COSTS AND BENEFITS OF MANAGERIAL INCENTIVES AND MONITORING IN LARGE US CORPORATIONS - WHEN IS MORE NOT BETTER

Recent research and public discourse on executive compensation and cor porate governance suggests a growing consensus that firms can and shou ld increase their control over top managers by increasing the use of m anagerial incentives and monitoring by boards of directors. This study departs from this consensus by offering an alternative perspective th at considers not only the benefits, but also the costs of both incenti ves and monitoring in large corporations. The study develops and tests a contingency cost/benefit perspective on governance decisions as res ource allocation decisions, proposing how and why the observed levels of managerial incentives and monitoring may vary across organizations and across time. Specifically, the study suggests that: (I) firms that are more risky face greater costs when using incentive compensation c ontracts for top managers, thus reducing the expected level of incenti ve compensation use for such firms; (2) firms facing this problem of l ow incentive compensation use can realize greater benefits from higher levels of board monitoring, and thus are likely to rely more on board monitoring; and (3) firms with more complex corporate strategies face higher costs in wing board monitoring, and are thus likely to rely le ss on board monitoring as a source of controlling top management behav ior. The study also proposes that within this contingency perspective there may be diminishing 'behavioral returns' to increases in monitori ng and incentives. These hypotheses are tested using extensive longitu dinal data from over 400 of the largest U.S. corporations. The support ive findings suggest that maximal levels of incentives and monitoring are not necessarily optimal, and that a firm's strategy may not only h ave significant product/market implications, but also corporate govern ance implications.