We develop a model to examine implications of empowering shareholders to replace directors. We find that shareholder empowerment functions as a double‐edged sword. On the one hand, it can weaken ineffective boards' incentive to hold on to their position. On the other hand, it can induce both effective and ineffective boards to behave strategically to avoid a potential dismissal. As a result, empowerment does not necessarily increase firm value; in some cases, empowerment exacerbates the agency problem it is intended to address. Giving shareholders the power to set board compensation (have a “say on pay”) can mitigate these problems. However, even when empowerment benefits (harms) the shareholders, firm value may decrease (increase). Finally, we discuss empirical and policy implications of the main findings.

We examine a principal–agent setting in which the principal uses a performance measurement system for multiple purposes—to provide incentives and for retention decisions. The principal chooses the nature and extent of bias in the system, which determines whether the performance report is stringent, neutral, or lenient relative to the unobservable actual outcome. We show that when the report is used only for incentive purposes (an incentive role), stringency alleviates moral hazard. On the other hand, when the principal's objective is to minimize the cost from incorrect retention and firing decisions (a fit evaluation role), there is a demand for leniency. Surprisingly, however, we show that adding a fit evaluation role to a system serving an incentive role can accentuate the demand for stringency because stronger incentives can also indirectly improve retention decisions.