Essays in Corporate Finance

Incentives of executives and board of directors play an important role in corporate decisions. Principal agent theory suggests a tradeoff between risk and incentives in optimal compensation contracts for managers. The first essay of this dissertation explores the relationship between the distribution of incentive compensation among top executives and firm risk. This essay develops and tests a two-agent model of optimal incentive compensation for corporate executives. The model investigates the effects of firm risk and cooperation among executives in the design of incentive contracts and offers two contrasting propositions: 1. When importance of cooperation is invariant to risk, the ratio of incentive compensation of the CEO to that of other top executive(s) increases with risk. 2. In contrast, when importance of co-operation increases with risk, the ratio of incentive compensation first increases and then decreases with risk. Using EXECUCOMP data from 1992 to 2002 I test these propositions and find evidence supporting the second proposition, but none for the first.The second essay examines the relation between board independence of target firms and the returns to targets and acquirers around takeover announcements. Using a sample of 232 large relative size takeovers, I reexamine whether target board independence is related to target or acquirer returns and their share in the total wealth change around announcements. Unlike Cotter et al. (1997), I do not find independent target boards to be associated with higher target premiums or lower acquirer returns. Similar to Wulf (2004), I find that target returns are lower when target CEOs obtain CEO positions in the merged firm. However, target board independence does not mitigate the lower premium targets receive when their CEOs are CEOs of the merged firm. I conclude that the takeover market is competitive such that target board independence is unrelated to gain sharing between targets and acquirers in larger relative size takeovers.