Description:
The conflict of interest between shareholders in insider-dominated firms generates the agency problem of profit diversion, which intensifies when the controlling shareholder is the CEO. In a theoretical model, we show that incentive contracts can be employed to discipline diversion, and how they differ from contracts designed to prevent shirking. In equilibrium, contracts of inside-CEOs display lower expected pay, but higher pay-for-performance sensitivity than those of professional managers. This different design affects the choice between inside and outside CEOs. We test our hypotheses on Italian public family firms (2000-2017), accounting for the firm-specific corporate governance settings and for selection-based endogeneity by exploiting the genealogy of the controlling family