The Complementarity Between Signal Informativeness and Monitoring

Abstract

A firm that must decide whether to retain or terminate a manager can rely on several sources of information to assess managerial ability. When it relies on a performance signal and monitoring, we show that a more informative signal can surprisingly increase the value of monitoring. Then, signal precision and monitoring are complements. This happens if a more precise information system makes some signals more negative indicators of managerial ability that still do not trigger termination. When the turnover cost is high enough and the manager is more entrenched after a positive performance, an increase in signal precision increases expected monitoring. In firms with a high turnover cost, a less informative signal is compounded by worse monitoring after a disappointing performance. This "bad corporate governance trap" makes it hard for these firms to eventually improve performance.

Earnings quality and board meeting frequency

“…Our hypothesis also builds on prior accounting research that investigates the effects of earnings quality measures on governance mechanisms and other formal contracts, such as compensation and financing agreements, as well as CEO termination decisions (e.g., Bushman et al 2004;Armstrong et al 2010;Chaigneau and Sahuguet 2023). While there is ample evidence that accounting earnings are used extensively in formal contracts, we know little about how earnings quality affects the board's internal workings.…”