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Does Pay Activism Pay Off for Shareholders? Shareholder Democracy and Its Discontents

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  • Sudipto Dasgupta

    (Department of Finance, Chinese University of Hong Kong, Shatin, Hong Kong; Lancaster University, Lancaster, LA1 4YX, United Kingdom; Center for Economic Policy Research, Washington, DC 20009)

  • Thomas H. Noe

    (Saïd Business School and Balliol College, University of Oxford, Oxford OX1 3BJ, United Kingdom)

Abstract

Typically, shareholders are not sure whether boards act in their interest or have been captured by management. They are also less well informed than boards about firm investment opportunities and operating conditions. We develop a model, consistent with these observations, in which discretionary compensation payments to managers might increase firm value or might simply enrich managers at the expense of shareholders. After observing the board’s compensation and investment policies, shareholders use Bayes’s rule to update the probability that the board is captured. Shareholders are “outraged” if this updated probability is sufficiently large. Outrage is costly for the board. Shareholder democracy, by enabling outrage to constrain board actions, typically lowers firm value relative to either governance regimes that insulate boards from shareholder outrage or regimes that ban discretionary compensation altogether.

Suggested Citation

  • Sudipto Dasgupta & Thomas H. Noe, 2019. "Does Pay Activism Pay Off for Shareholders? Shareholder Democracy and Its Discontents," Management Science, INFORMS, vol. 65(4), pages 1810-1832, April.
    • Handle: RePEc:inm:ormnsc:v:65:y:2019:i:4:p:1810-1832
    DOI: 10.1287/mnsc.2017.2854
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    1. Pablo Ruiz‐Verdú & Ravi Singh, 2021. "Public Thrift, Private Perks: Signaling Board Independence with Executive Pay," Journal of Finance, American Finance Association, vol. 76(2), pages 845-891, April.

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