Executive Compensation
ISSN 1045-6333
HARVARD
JOHN M. OLIN CENTER FOR LAW, ECONOMICS, AND BUSINESS
EXECUTIVE COMPENSATION AS
AN AGENCY PROBLEM
Lucian Arye Bebchuk and Jesse M. Fried
Discussion Paper No. 421
04/2003
Harvard Law School
Cambridge, MA 02138
The Center for Law, Economics, and Business is supported by a grant from the John M. Olin Foundation.
This paper can be downloaded without charge from:
The Harvard John M. Olin Discussion Paper Series: http://www.law.harvard.edu/programs/olin_center/ The Social Science Research Network Electronic Paper Collection: http://papers.ssrn.com/abstract_id=364220 This paper is also a discussion paper of the
John M. Olin Center 's Program on Corporate Governance.
Last revision: April 2003
Executive Compensation as an Agency Problem
Lucian Arye Bebchuk* and Jesse M. Fried**
Abstract
This paper provides an overview of the main theoretical elements and empirical underpinnings of a “managerial power” approach to executive compensation. The managerial power approach recognizes that boards of publicly traded companies with dispersed ownership do not bargain at arms’ length with managers, and that managers are able to influence their own pay arrangements. It thus views executive compensation not only as an instrument for addressing the agency problem between managers and shareholders, but also as part of the problem itself. We show that the managerial power approach can help explain many features of the executive compensation landscape, including ones that researchers have long viewed as puzzling. We explain that managerial influence produces efficiency costs because managers’ seeking and camouflaging of rents produces inefficient arrangements that result in weak or even perverse incentives.
Keywords: Corporate governance, managers, shareholders, boards, directors, executive compensation, stock options, principal-agent problem, agency costs, rent extraction, golden parachutes, executive loans, compensation consultants.
JEL
HARVARD
JOHN M. OLIN CENTER FOR LAW, ECONOMICS, AND BUSINESS
EXECUTIVE COMPENSATION AS
AN AGENCY PROBLEM
Lucian Arye Bebchuk and Jesse M. Fried
Discussion Paper No. 421
04/2003
Harvard Law School
Cambridge, MA 02138
The Center for Law, Economics, and Business is supported by a grant from the John M. Olin Foundation.
This paper can be downloaded without charge from:
The Harvard John M. Olin Discussion Paper Series: http://www.law.harvard.edu/programs/olin_center/ The Social Science Research Network Electronic Paper Collection: http://papers.ssrn.com/abstract_id=364220 This paper is also a discussion paper of the
John M. Olin Center 's Program on Corporate Governance.
Last revision: April 2003
Executive Compensation as an Agency Problem
Lucian Arye Bebchuk* and Jesse M. Fried**
Abstract
This paper provides an overview of the main theoretical elements and empirical underpinnings of a “managerial power” approach to executive compensation. The managerial power approach recognizes that boards of publicly traded companies with dispersed ownership do not bargain at arms’ length with managers, and that managers are able to influence their own pay arrangements. It thus views executive compensation not only as an instrument for addressing the agency problem between managers and shareholders, but also as part of the problem itself. We show that the managerial power approach can help explain many features of the executive compensation landscape, including ones that researchers have long viewed as puzzling. We explain that managerial influence produces efficiency costs because managers’ seeking and camouflaging of rents produces inefficient arrangements that result in weak or even perverse incentives.
Keywords: Corporate governance, managers, shareholders, boards, directors, executive compensation, stock options, principal-agent problem, agency costs, rent extraction, golden parachutes, executive loans, compensation consultants.
JEL
References: Abelson, Reid. 2001. “Enron Board Comes Under a Storm of Criticism,” N.Y. Times, December 16, C4. Agrawal, Anup and Charles R. Knoeber. 1998. “Managerial Compensation and the Threat of Takeover.” Journal of Financial Economics. 47:2, pp. 219-239. Aggarwal, Rajesh K. and Andrew A. Samwick. 1999. “Executive Compensation, Strategic Competition, and Relative Performance Evaluation: Theory and Evidence.” Journal of Finance. 54:6, pp. 1999-2043. Baker, George P., Michael C. Jensen, and Kevin J. Murphy. 1988. “Compensation and Incentives: Practice vs. Theory.” Journal of Finance 63:3, pp. 593-616. Balsam, Steven. 2002. An Introduction to Executive Compensation (Academic Press). Oren Bar-Gill and Lucian Bebchuk. 2002. “Misreporting Corporate Performance.” Working Paper No. 400, Harvard Olin Center for Law, Economics, and Business, available at