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Financial structure, managerial compensation and monitoring

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When a firm has external debt and monitoring by shareholders is essential, managerial bonuses are shown to be an optimal solution. A small managerial bonus linked to firm's performance not only reduces moral hazard between managers and shareholders, but also between creditors and monitoring shareholders. A negative relation between corporate bond yields and managerial bonuses can be predicted. Furthermore, the model shows how higher managerial pay-performance sensitivity goes hand in hand with greater company leverage and lower company diversification. These predictions find some support in the empirical literature.

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en

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application/pdf

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http://eprints.lse.ac.uk/24634/1/dp576.pdf

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