Managerial Compensation and Trading Activity

Abstract

We propose that due to a lack of sophistication and unfamiliarity with accounting conventions, nave (unsophisticated) investors may be unable to discern true managerial compensation from financial statements. Compensation may therefore be higher when such investors are more active. Technologies that lower trading costs for retail investors encourage entry of such investors and raise expected compensation. In general, such compensation can be reduced through requirements that increase disclosure transparency. Empirical tests provide support to our hypothesis that direct and indirect compensation should be higher in stocks with higher liquidity, which are likely to have greater unsophisticated investor participation.

TOPICS: Manager selection, equity portfolio management, accounting and ratio analysis