Executive Compensation: A Model of Disclosure Choice


  • Pascal Frantz,

    Corresponding author
    • Address for correspondence: Pascal Frantz, London School of Economics, Houghton Street, WC2A 2AE, UK. e-mail: p.frantz@lse.ac.uk

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  • Norvald Instefjord,

  • Martin Walker

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    • The first author is at the London School of Economics, Houghton Street, London. The second author is at the University of Essex, Colchester, UK. The third author is at the Manchester Business School, Manchester, UK. The authors wish to acknowledge the constructive comments offered by the associate editor, Stephen Young, and an anonymous referee. (Paper received October, 2010; revised version accepted May, 2013).


Recent public policy debates have led to increased calls for full transparency of executive compensation. However, in practice, many firms are reluctant to disclose the full details of how they link executive compensation to performance. One possible reason for lack of full disclosure is that managers use their power to hide the details of their compensation plan in order to disguise opportunistic rent extraction. If this is the reason for secrecy, then public policy designed to force firms to provide full disclosure is unlikely to be resisted by shareholders. However, another possible explanation for less than full transparency is that some degree of secrecy about executive compensation may be in the interest of the company and its shareholders. If this explanation is correct, then public policy moves to increase transparency may be met by counter moves designed to protect managers and shareholders from such policies.

In this paper we investigate if full disclosure of executive compensation arrangements is always optimal for shareholders. We develop a model where optimal executive remuneration solves a moral hazard problem. However, the degree to which the moral hazard problem affects the shareholders depends on hidden information, so that disclosure of the executive compensation scheme will typically reveal the hidden information, which can be harmful to shareholders. The model derives, therefore, the optimal disclosure policy and the optimal remuneration scheme. We find that the shareholders are better off pre-committing not to disclose the executive compensation scheme whenever possible. Executive directors are shown to be better off too in the absence of disclosure of executive compensation schemes. An argument for mandating disclosure is that it provides better information to shareholders but our analysis demonstrates that disclosure does not necessarily achieve this objective.

The results suggest that less than full disclosure can be in the interest of shareholders, the reason for this being that disclosures cannot be made selectively to shareholders but will also be made to strategic opponents. This will be the case if the board of directors and the remuneration committee includes enough independent directors. Whether or not non-disclosure to shareholders is in their interest is however an empirical matter involving a trade-off between the proprietary costs associated with disclosure to shareholders and the costs of potential collusion between executive and non-executive directors associated with non-disclosure.