Institutional Investor Monitoring Motivation and CEO Compensation

This paper examines whether the motivation of institutional investors in monitoring a firm can influence CEO compensation. We find that greater motivated monitoring institutional ownership is associated with a higher pay-performance sensitivity of CEO compensation, which cannot be explained by traditional measures of institutional ownership. Further, we find that the economic effect of institutional monitoring on the pay-performance sensitivity falls with decreasing institutions’ monitoring motivation. Finally, we document that CEO pay– performance sensitivity is more, if not only, related to the unsystematic component of corporate performance in firms with greater motivated monitoring IO. These results suggest that how well the institutions can serve their monitoring role and mitigate the agency problem between shareholders and managers depends on the proportion of ownership held by motivated monitoring institutions.