Passive shareholders and active managers : an empirical test of Admati and Pfleiderer's hypothesis

Admati and Pfleiderer (2006) demonstrate that under some conditions, linking CEO pay to share price performance may aggravate agency conflicts. Two fundamental conflicts are considered: the manager may take value-destroying, privately beneficial ('bad') actions, or value-enhancing, privately costly ('good') actions. Applying a structural equation model to a global data set, we find that when institutions encouraging 'good' ('bad') managerial conduct are lacking, CEO pay is more (less) strongly associated with share price performance. Our analysis suggests that the Wall Street Rule as a governance mechanism varies in its effectiveness to cope with different categories of agency conflict.