Give 'Em Enough Rope: Optimal Design of Executive Pay and Rent Extraction

89 Tex. L. Rev. See Also 143 (2011)

Arizona Legal Studies Discussion Paper No. 13-08

15 Pages Posted: 11 Feb 2013

See all articles by Simone M. Sepe

Simone M. Sepe

University of Arizona - James E. Rogers College of Law; University of Toulouse 1 - Université Toulouse 1 Capitole; IAST - Fondation Jean-Jacques Laffont - TSE; European Corporate Governance Institute (ECGI)

Date Written: February 7, 2013

Abstract

In his novel contribution to the ongoing debate over executive compensation, Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, 89 Tex. L. Rev. 1113 (2011), Professor Jesse M. Fried points to a problem that has been, as of yet, unexplored by legal scholars. He argues that managers whose compensation is equity-based obtain extra returns when their firms engage in bargain share repurchases and overpriced equity issuances. Consequently, managers have perverse incentives to effect these transactions even when they potentially reduce shareholder value. Fried suggests that to remedy these inefficiencies, managers should participate in their firms’ share repurchases and equity offerings on the same terms that are offered to the firms’ investors. This would eliminate the opportunity for managers to take in extra returns, thereby inducing them to engage in those transactions only when they are value-increasing.

This Response offers two criticisms of Fried’s argument. First, it challenges the idea that preventing managers from capturing extra returns always leads to increased efficiency. Since the problem of managerial moral hazard can take multiple forms, leaving managers some extra returns may reduce the likelihood that managers will waste corporate assets. Second, this Response argues that as opposed to the social cost implied by share repurchases, that of overpriced equity offerings is unclear. Indeed, while bargain share repurchases may inefficiently substitute corporate assets, no substitution of assets takes place when the firm conducts an equity offering.

Keywords: executive compensation, equity issuances, executive pay, manager incentives

Suggested Citation

Sepe, Simone M., Give 'Em Enough Rope: Optimal Design of Executive Pay and Rent Extraction (February 7, 2013). 89 Tex. L. Rev. See Also 143 (2011); Arizona Legal Studies Discussion Paper No. 13-08. Available at SSRN: https://ssrn.com/abstract=2214708

Simone M. Sepe (Contact Author)

University of Arizona - James E. Rogers College of Law ( email )

P.O. Box 210176
Tucson, AZ 85721-0176
United States

University of Toulouse 1 - Université Toulouse 1 Capitole ( email )

2 Rue du Doyen-Gabriel-Marty
Toulouse, 31042
France

IAST - Fondation Jean-Jacques Laffont - TSE ( email )

21 allée de Brienne
31015 Toulouse Cedex 6
Toulouse Cedex, F-31042
France

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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