Date: 13 Aug 2014

The effects of managerial discretion on moral hazard related behaviour: German evidence on agency costs

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Based on a sample of German quoted firms in the period 2006–2010 this paper measures the impact of managerial incentives, entrenchment and blockholder monitoring on managerial behaviour typically associated with moral hazard. This is motivated by the observation that while typically the German institutional environment is characterised by the type-II conflict between large and dispersed investors, a number of regulatory and behavioural changes suggest that the issue of managerial leeway and complacency has gained in importance. I find that managerial entrenchment as proxied by excess compensation is associated with higher agency costs, i.e. lower asset turnover and higher discretionary expense ratio and acquisition activity, respectively. In contrast, there is no evidence of an incentive alignment effect of long-term compensation components. Concerning blockholder influence, while general blockholder presence has inconclusive effects, the presence of a blockholder belonging to the traditionally influential group of families, strategic investors and banks is significantly associated with lower agency costs. However, the presence of any other blockholder is associated with higher agency costs stemming from managerial discretion. Overall, this partly conforms to the hypothesis that German corporate governance may be changing in that the problem of managerial complacency and entrenchment has gained in importance; at the same time dominant blockholders still seem to exert influence on corporate policy.