Inelastic Labor Markets and Directors’ Reputational Incentives

The Harvard Law School Forum on Corporate Governance and Financial Regulation 2017-07-13

Posted by Christopher Armstrong, The Wharton School of the University of Pennsylvania, on Thursday, July 13, 2017
Editor's Note: Christopher Armstrong is EY Associate Professor of Accounting at The Wharton School of the University of Pennsylvania. This post is based on a recent paper authored by Professor Armstrong; David Tsui, Assistant Professor of Accounting at the University of Southern California Marshall School of Business; and John D. Kepler, The Wharton School of the University of Pennsylvania.

In our recent paper, Inelastic Labor Markets and Directors’ Reputational Incentives, we examine the extent to which independent directors on corporate boards face consequences for their individual performance and how these consequences, in turn, shape directors’ incentives. Prior studies of directors’ incentives largely focus on collective performance measures that are necessarily common to all directors at a given firm (e.g., a firm’s stock price and accounting performance during a particular period of time does not differ across its directors). However, relying on collective measures of performance can create free-rider problems among directors and can dampen any resulting incentives. Thus, to understand the factors that motivate directors to act in shareholders’ interests, it is important to assess whether directors face appreciable consequences from their individual performance.