Internal capital markets, non-cash divestitures and managerial incentives

Management incentive contracts are postulated to alleviate the principal-agent conflict in the widely-held firms. This paper studies the effect of changes in CEO pay-performance sensitivity (delta), stock option convexity (vega) and performance-contingent pay on changes in firm excess value for the US public companies that undergo non-cash divestitures (spin-offs) during the 1992-2006 period. First, I find that at the time of the breakup the management is awarded high-powered incentives, however, these improved incentives do not transmit into higher firm value. The evidence seems to support the supposition that the senior management may use the restructuring to derive private benefits of control in the form of additional remuneration. Second, CEO option vega in the multi business firms seem not to lead to the higher risk-taking. Third, I find that in the diversified firms the CEOs with more influence over their boards perform better as compared to the CEOs with less decision-making power. Contrary to the theoretical predictions, I also find that firms which decide to break up are not traded at a discount and that the crucial characteristics of their internal capital markets (e.g., diversity of business units) remain unchanged after the divestiture. EFM classification:190, 210, 160, 150