Executive Compensation as an Agency Problem

Abstract

Executive compensation has long attracted a great deal of attention from financial economists. Indeed, the increase in academic papers on the subject of CEO compensation during the 1990s seems to have outpaced even the remarkable increase in CEO pay itself during this period (Murphy, 1999). Much research has focused on how executive compensation schemes can help alleviate the agency problem in publicly traded companies. To understand adequately the landscape of executive compensation, however, one must recognize that the design of compensation arrangements is also partly a product of this same agency problem.

The relationship between remuneration and financial performance for companies listed on the Johannesburg Stock Exchange

“…A variety of studies focus on executive compensation and how this can minimise the agency problem (Bebchuk & Fried 2003). Reward systems are designed to bridge the agency problem between shareholders and managers, but to bridge this gap, reward systems must be related to the performance of managers and the strategy of the company, and take into account the growth and nature of the company.…”

Determinants of CEO Compensation before and after the Financial Crisis

“…The principal-agent view (as articulated by Core et al 2003, among many others) suggests that boards design CEO compensation contracts so as to provide incentives for CEOs to work hard and maximize shareholder value [3]. Alternatively, the managerial power view (Bebchuk and Fried, 2003) asserts that CEOs exert influence over their boards that effectively allows them to participate in setting their own pay [4]. The two approaches suggest different explanations for large pay packages; under the principal-agent approach, high average levels of pay may be necessary to compensate the CEO for the risk he bears by having his compensation tied to firm performance (via stock and options), whereas under the managerial power approach high pay might indicate weak corporate governance-specifically, a high degree of leverage for the CEO over the board and compensation committee.…”

“…Under the principal-agent perspective, this relationship can be seen as reflecting the need to give the CEOs of larger firms, incentives commensurate with the larger economic impact of their actions (Gayle and Miller 2009) [17]. In contrast, the more cynical view of the managerial power approach would be that larger firms present CEOs with more opportunities to carve out rents (Bebchuk and Fried 2003).…”

“…We also used the firm's annual stock market performance (lagged) as an independent variable to measure pay for performance. 4 Profitability measures along with firm sales were taken from the Compustat database, while stock market and S&P data were gathered using the Center for Research in Security Prices (CRSP) database. We expect EPS and annual stock market returns to have a positive effect on incentive compensation.…”

“…We chose firm sales because the R-squared regression results were slightly higher when using firm sales versus market capitalization. 4 We tried both total and net stock market performance (subtracting out the benchmark index annual performance), but did not find differences in significance between the variables. consumer products, technology, industrial, and healthcare sectors each accounted for 15% to 17% of the sample.…”