Executive Compensation as an Agency Problem

Abstract

This paper provides an overview of the main theoretical elements and empirical underpinnings of a "managerial power" approach to executive compensation. Under this approach, the design of executive compensation is viewed not only as an instrument for addressing the agency problem between managers and shareholders but also as part of the agency problem itself. Boards of publicly traded companies with dispersed ownership, we argue, cannot be expected to bargain at arm's length with managers. As a result, managers wield substantial influence over their own pay arrangements, and they have an interest in reducing the saliency of the amount of their pay and the extent to which that pay is de-coupled from managers' performance. We show that the managerial power approach can explain many features of the executive compensation landscape, including ones that many researchers have long viewed as puzzling. Among other things, we discuss option plan design, stealth compensation, executive loans, payments to departing executives, retirement benefits, the use of compensation consultants, and the observed relationship between CEO power and pay. We also explain how managerial influence might lead to substantially inefficient arrangements that produce weak or even perverse incentives.

Investor pricing of CEO equity incentives

“…Stated in another way, CEO equity incentives can have an adverse effect on the quality of reported accounting information. As noted by Bebchuk and Fried (2003) and Jensen et al (2004), by promoting perverse financial reporting incentives and lowering the quality of accounting information, equity-based compensation can be a source of, rather than a solution for, the agency problem.…”

Corporate Governance, Ethics, and the Backdating of Stock Options

“…In doing so, we take a position similar to that of Bebchuk and Fried (2003), who suggest that while executive compensation schemes (e.g., stock options) were originally intended to help remedy the agency problem, they may have actually become ''part of the problem.'' In other words, granting stock options to executives does not necessarily discourage executives from pursuing their own interests at the expense of shareholders, but rather encourages them to do so.…”

“…Such an abuse took place as a result of business executives playing a 'dating game' with their firm's stock options without full disclosure, which in turn led to serve the executives' self-interests rather than the shareholders' interests. From this point of view, we look at the backdating of stock options as an agency problem (Bebchuk and Fried, 2003;Narayanan et al, 2007). Thus, we confine our focus in this paper to a discussion of the ethical aspects of the conflict of interests involving the backdating of stock options as a form of compensation between managers and shareholders and between directors and shareholders.…”

Impact of Say on Pay on Executive Compensation of Firms Listed on the Toronto Stock Exchange

“…However, longer-term studies show an improvement in the compensation-performance relationship (Frydman & Saks, 2010;Kaplan & Rauth, 2010). A weak link between these two elements raises questions about the effectiveness of boards' oversight of CEOs (Bebchuk & Fried, 2003, 2005Walsh, 2009). In such instances, managerial power derives from the lack of independence of board members and results in sub-optimal performance (Brick, Palmon, & Wald, 2006).…”