Taking the Blue Pill: The Imponderable Impact of Executive Compensation Reform

Abstract:     
No other corporate governance issue captures the imagination and frustration of the American public and politicians more than executive compensation. Despite decades of varied responses to address soaring executive compensation such as tax measures, board independence requirements, and mandated disclosures, executive compensation levels continue to soar, as does the saliency of executive compensation as a political issue. Most of the legal literature on executive compensation has focused on the conduct of wayward managers. This article, however, examines the impact of political behavior (i.e., lawmaker opportunism) on executive compensation reform. For lawmakers, executive compensation reform operates as a blue pill - a mechanism for lawmaker diversion and responsibility-shifting that diverts corporate constituent and scholarly attention away from more important corporate governance and socio-economic issues. This scenario threatens the prospect of optimal reform.

Executive compensation reform is analogous to a service exhibiting credence characteristics. Credence characteristics are service attributes whose quality cannot be fully determined even after significant use. Examples of services with substantial credence characteristics include automobile repair services, medical treatments, and corporate law. In the corporate law context, corporate lawmakers - the state of Delaware and the federal government - not only provide reform services, but also act as experts and diagnose corporate governance problems. Information asymmetries between lawmakers and various corporate constituencies (e.g., managers, shareholders, and populist groups) create perverse incentives for opportunistic lawmaker behavior. The unobservable impact of executive compensation reform provides lawmakers with added discretion that is often used for incremental, moderate, or conservative corporate reforms, even in the face of crisis. On the other hand, sweeping reforms are unlikely because they pose a serious risk to political capital. Therefore, lawmaker cries for executive compensation reform should be approached with vigilance.

Number of Pages in PDF File: 68

Keywords: pay, Delaware, credence, shareholder, public, executive compensation, SEC, Securities and Exchange Commission, disclosure, regulation, rulemaking, administrative agency, congress, legislation, business, corporation, corporate governance, politics, political, search firm, consultant, managers

JEL Classification: D61, D72, D73, G18, G38, J38, K20, K22, K23, P16

Accepted Paper Series