Codes of best practices in competitive markets for managers

Abstract

We study the corporate governance of firms in environments where possibly heterogeneous shareholders compete for possibly heterogeneous managers. A firm, formed by a shareholder and a manager, can sign either an incentive contract or a contract including a Code of Best Practice. A Code allows for better management control, but makes it hard for managers to react quickly when market conditions change. Codes tend to be adopted in markets with low volatility and in environments where managers obtain low levels of benefits. The firms with the best projects tend to adopt a Code when managers are not too heterogeneous, while the best managers tend to be hired through incentive contracts when the projects are similar. Although the matching between shareholders and managers is often positively assortative, shareholders with the best projects might be willing to renounce hiring the best managers; instead, signing contracts including Codes with lower-ability managers