Among various governance mechanisms, compensation policy has been argued to be one of the most important factors in organisational success because it helps align interests of managers to those of shareholders. The notion is that effective compensation policies, particularly incentive-based pay, induce managers to exert costly effort to increase their firms ' value. In addition, closely linking firm performance with CEO rewards by granting stock options should address the risk aversion of managers and incentivize them to undertake risky and shareholder-wealth-increasing investments that
they would otherwise avoid. On the other hand, based on the managerial power approach, some argue that executive compensation is not only a potential instrument for addressing the agency problem but also a part of the agency problem itself. For example, Benmelech et al. (2010) argue that in a model with asymmetric information, stock-based ...
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... may lead to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions (Cooper et al., 2014). Second, stock-option features differ substantially across countries. For instance, performance-based vesting conditions have traditionally been uncommon in the US, although they are widespread in Australia. Such performance thresholds might encourage CEOs to work harder to meet thresholds, therefore resulting in a positive association between incentive pay and stock performance. Finally, with the introduction of the best corporate governance practice recommendations in 2003 and CLERP 9 in 2004, shareholders have an increased input into the remuneration process by way of a non-binding vote on the Remuneration Report. As a result, it is expected that there is a close link between managerial compensation and future firm value.
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