When you are using short-term options or other mechanisms to pay managers only in terms of their share-price performance, you create perverse incentives for them to commit fraud. I think that this is something that people did not think about when they adopted economic theories. Basically, in the economic jargon this is called “principal agent theory.” Principal agent theory was invented and advocated beginning about 20 or 30 years ago. That’s now seized the day with respect to executive compensation debates, where you basically see managers as the agents of shareholders, and that’s the only relationship that matters.
What I argue… is that there are a number of other considerations that matter. Employees matter, and how they are motivated [matters]. That really is not taken into account in a simple principal agent theory. The other group that matters [includes] other creditors, bond holders and other capital providers of the enterprise. The role of retained earnings in a firm is really under-appreciated in the principal agent models. So, a main argument is that these economic models that have driven this idea that managers should only manage to [increase] share price, particularly in the short term, are wrong. They’re the product of economic theories that I think at this point have been shown to be wrong.
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