The Managerial Power Approach – A Tautology Revisited

Abstract

CEO compensation is the subject of an ongoing and heated debate. Over the last decade this debate was spurred by the so called managerial power approach. This approach holds that actual compensation of managers is excessive and not consistent with basic principles of optimal contracting theory. Compensation, it suggests, is a result of managerial power. In this view, executives have power and are able to use their power to generate compensation arrangements which are favorable to them. To substantiate their claims, proponents of the managerial power approach refer to empirical evidence that seemingly establishes the existence of a positive association between power and compensation.

However, we will demonstrate that there is not a single piece of empirical evidence of a positive link between power and compensation. This is because the existence of a positive association between power and compensation already and only follows from the very definition of “power” and therefore cannot be empirically tested. The core statement of the managerial power approach is nothing more than a tautology; as a result, the managerial power approach as such has no empirical foundation. Evidence seemingly corroborating the managerial power approach is simply misinterpreted by its proponents.

Keywords: Managerial power approach, Executive compensation, Corporate Governance, Pay for performance

JEL Classification: G32, G34, J33, M12