Executive Compensation as an Agency Problem

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.

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