Are board monitoring and CEO incentives substitutes for each other? Evidence from Australian market reaction to acquisition announcements

We examine the hypotheses that board monitoring and CEO stock incentives are effective mechanisms and substitutes for each other using the Australian acquisition market as an experimental field. The results confirm that Australian firms use board monitoring and CEO incentives as substitutes for each other, but the effects of these mechanisms on the acquirers' return do not support the notion that each can substitute for the role of the other. We find the market reaction to acquisitions made by acquirers with low monitoring-high CEO incentives is significantly higher than the reaction to those made by acquirers with high monitoring-low CEO incentives. Further analyses confirm that monitoring level does not make a difference when the CEO is granted high or low incentives but reduces the gain from M&As when used as a substitute for CEO incentives. The latter, if high enough, effectively aligns the managers' interests with those of the shareholders. Our findings hold when we control for other variables and possible endogeneity in the main variables of interest. These results suggest that Australian firms, on average, focus on the board's monitoring role at the expense of its advisory role, a setting that reduces firm value if used as a substitute for CEO incentives.