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When Less is More: How Limits on Executive Pay Can Result in Greater Managerial Effort and the Adoption of Better Strategies

We derive conditions under which state-imposed limits on executive compensation can enhance efficiency and benefit shareholders (but not executives). Having their hands tied in the future allows a board of directors to credibly enter into relational contracts with executives that are more efficient than performance-based contracts. This in turn can have implications for firm strategy and the ideal composition of the board. The analysis also offers insights into the political economy of executive-compensation reform.