Compensation And Organization: Internal Vs. External Market Monitoring

The author examined the efficiency of managerial incentive contracts under alternative market monitoring via stock-based compensation. The author focuses on multi-divisional organizations in which the interaction among agents within an organization has significant impact on firm value. The author's model explains the interaction between internal and external monitoring of management. Organizational forms affect the way information is aggregated for the managerial incentive purpose. For example, under equity carve-outs, relative compensation ratio between two firms is independent of internal externality (synergy), while synergy affects the internal compensation ratio. The author found that stock-based compensation is not efficient for the incentive purpose. However, two-stock compensation becomes more flexible.