The conflicts of interest between parties and

The subject of corporate governance focuses
on the way in which companies are governed, specifically, it “deals with the
ways in which suppliers of finance to corporations assure themselves of getting
a return on their investment” (Shleifer
and Vishny 1997: 737). A corporation is defined as a legal entity that
is separate from its owners. Corporations
are owned by shareholders who elect a board of directors to represent their
interests, who in turn appoint a CEO to manage the organization. As
shareholders are not always able to handle the day-to-day business of the
company, they choose an agent to run the company. CEOs act as an agent of the
shareholders, who are the principals of the company. It is thus clear that
shareholders want CEOs to act in the best interest of the company. If this is
not the case, problems related to agency theory, also referred to as the
separation of ownership and control, can arise. These problems arise when the
objectives of CEOs are not aligned with those of shareholders. Agency costs are
the internal costs resulting from these conflicts of interest between parties
and also as a result of information asymmetry as shareholders cannot directly
observe what management is doing (moral hazard).
Corporate governance mechanisms are aimed at minimizing these agency costs, in
order to maximize shareholder wealth. It is of great economic importance to
understand how these mechanisms affect shareholder wealth (Masulis et al. 2007). In the
context of mergers and acquisitions, agency issues arise when managers
undertake M&A due to irrationality or because they are motivated by their
private benefits and the effectiveness of corporate governance mechanisms can
impact the quality of- and performance following a transaction. It it thus
important to align the interest of the CEO with the interests of the company.
For this reason, it is important to find out what the best form of CEO
compensation is, so that the manager is incentivized to take actions that
benefit shareholders. How do we align the interests of CEOs to those of equity
holders, and thus benefit the performance of the firm in the long-run? In order
to investigate this, we need to investigate the different ways in which CEOs
are compensated and how they can be incentivized to handle in such a way that
is most advantageous for firm performance. Specifically, does the type of
executive compensation affect the quality and outcome of takeover decisions?
This paper will investigate the effect of various types of managerial incentive
compensation on acquirer returns. I am expecting a relationship between the
variables based on the conclusion by Lehn and Zhao (2006) that effective implementation of corporate
governance mechanisms generally succeeds in minimizing the recurrence of
value-destroying deals made by managers.