Building Friendship with Boss: Strategic Prosocial Behaviors in the Agency Model

Abstract

In reality, friendship is not a zero or one relationship and it is not always reciprocal. We analyze how the degreeof CEO-directors friendship and players’ recognition of this degree can affect the actions in the agency model.The degree of friendship will determine ones’ prosocial preferences, which then affect managerial efforts andcompensation. Our results show that, when players’ prosocial preferences are publicly known and when the CEOcares more about directors, he puts in more effort to increase the firm value. On the other hand, if directors caremore about the CEO, then they are willing to reward a higher salary to compensate for the CEO’s effort cost.However, if directors were to know that the CEO cares about their welfare more and the CEO himself would havea high incentive to put in effort, then directors should reward the CEO less! This indicates that the CEO has anincentive to hide his prosocial preference. Our discussions on the two private information cases help explainplayers’ incentives of strategic hiding, by characterizing the pooling, separating and partial pooling equilibria inthe signaling frame