Corporate Governance Going Astray: Executive Remuneration Built to Fail

Abstract

Modern remuneration systems for executive directors include substantial elements of performance based pay. The idea behind this is that by rewarding executives for performance their interests become aligned with those of the company’s shareholders, thus bridging the principal-agent gap. Executive remuneration through performance based pay has become an explicit corporate governance tool that is supposed to improve the governance of companies. Others have argued that the governance and design of performance based pay system is often poor, as result of which the principal-agent problem actually increases. This paper argues that even if we can improve the governance and design of executive performance based pay, it cannot be made to work because people behave differently than performance based pay assumes. Research revealing our bounded rationality, bounded awareness and bounded ethicality shows that we simply cannot handle executive performance based pay. Regulation will not solve the problem, what is needed is a paradigm change, a refocusing of attention by shareholders, non-executive and executive directors. Such a paradigm change requires a deconstruction of the current myths surrounding performance based pay and the creation of new remuneration narratives.

Keywords: corporate governance, executive remuneration, performance based pay

JEL Classification: G34, J33, K22