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Executive Compensation as an Agency Problem

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Jesse M. Fried

Harvard Law School; European Corporate Governance Institute (ECGI)

July 2003

CEPR Discussion Paper No. 3961

This Paper provides an overview of the main theoretical elements and empirical underpinnings of a 'managerial power' approach to executive compensation. Under this approach, the design of executive compensation is viewed not only as an instrument for addressing the agency problem between managers and shareholders but also as part of the agency problem itself. Boards of publicly traded companies with dispersed ownership, we argue, cannot be expected to bargain at arm's length with managers. As a result, managers wield substantial influence over their own pay arrangements, and they have an interest in reducing the saliency of the amount of their pay and the extent to which that pay is de-coupled from managers' performance. We show that the managerial power approach can explain many features of the executive compensation landscape, including ones that many researchers have long viewed as puzzling. Among other things, we discuss option plan design, executive loans, retirement benefits, payments to departing executives, the use of compensation consultants, and the observed relationship between CEO power and pay. We also explain how managerial influence might lead to substantially inefficient arrangements that produce weak or even perverse incentives.

Number of Pages in PDF File: 30

Keywords: M14, corporate governance, managers, shareholders, boards, directors, executive compensation, stock options, principal-agent problem, agency costs, rent extraction, golden parachutes, executive loans, compensation consultants, expensing

JEL Classification: D23, G32, G34, G38, J33, J44, K22

working papers series

Date posted: August 27, 2003  

Suggested Citation

Bebchuk, Lucian A. and Fried, Jesse M., Executive Compensation as an Agency Problem (July 2003). CEPR Discussion Paper No. 3961. Available at SSRN: http://ssrn.com/abstract=438720

Contact Information

Lucian A. Bebchuk (Contact Author)
Harvard Law School ( email )
Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)
HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)
Jesse M. Fried
Harvard Law School ( email )
1575 Massachusetts
Griswold Hall 506
Cambridge, MA 02138
United States
617-384-8158 (Phone)
HOME PAGE: http://www.law.harvard.edu/faculty/directory/10289/Fried
European Corporate Governance Institute (ECGI) ( email )
B-1050 Brussels
Feedback to SSRN

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