Mutual Monitoring within Top Management Teams: A Structural Modeling Investigation

Mutual monitoring as a solution to moral hazard has been extensively studied by theorists. However, do shareholders actually take advantage of mutual monitoring among executives to design individual compensation? This paper non-parametrically identi…es and tests three structural models of principal-multiagent moral hazard using the data of S&P1500 …rms from 1993 to 2005. The Mutual Monitoring with Individual Utility Maximization Model is the most plausible one to rationalize the data. The No Mutual Monitoring Model is also plausible but relies on the assumption that managers have heterogeneous risk preferences across …rm characteristics. The Mutual Monitoring with Total Utility Maximization Model is rejected by the data. This paper indicates that shareholders seem to recognize and exploit complementary incentive mechanisms, such as mutual monitoring among self-interested top executives, to design compensation. Keywords: Mutual Monitoring, Moral Hazard, Top Management Team, Executive Compensation, Semiparametric Identi…cation, Structural Estimation, Moment Inequalities. I am indebted to my dissertation committee— George-Levi Gayle, Jonathan Glover (co-chair), Pierre Jinghong Liang, and Robert Miller (co-chair)— for their invaluable guidance and support. I also thank Michael Ewens, Diane Denis, Douglas Schroeder, Jack Stecher, Ran Zhao, and seminar participants at Carnegie Mellon for their comments. All errors are my own. Li is a Ph.D. candidate in accounting at Carnegie Mellon University. E-mail: [email protected].