Are Top Management Teams Compensated as Teams? A Structural Modeling Approach

49 Pages Posted: 22 Feb 2018 Last revised: 28 Jul 2019

See all articles by Chen Li

Chen Li

Stan Ross Department of Accountancy, Zicklin School of Business, Baruch College, The City University of New York

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Date Written: June 18, 2019

Abstract

This paper develops an empirical approach to explicitly test two multi-agent moral hazard models on executive compensation in S&P 1500 firms, which distinguish between a team perspective and an individual perspective. This approach assesses which model is more robust at rationalizing the observed relationship between executive compensation and firm performance. The results favor the team perspective under which unilateral shirking is assumed infeasible for managers. The analysis rejects the individual perspective under which each manager can unilaterally shirk. This paper also quantifies three model-based measures of agency costs. The risk premium can explain up to 37% of total compensation for higher-paid managers in large firms. This upper bound is higher than that of lower-paid managers and all managers in small firms. Shareholders could experience a reduction in equity return by 0.04-0.15 due to managers shirking. In addition, shareholders could benefit from switching from an individual-perspective contract to a team-perspective contract. Such counterfactual analysis predicts the risk premium could be reduced by $1 million-$17 million in the compensation of the higher-paid managers and $0.1 million-$3 million in the compensation of the lower-paid managers.

Keywords: Moral Hazard, Top Management Team, Executive Compensation, Structural Model

JEL Classification: D82, J33, M12, M52

Suggested Citation

Li, Chen, Are Top Management Teams Compensated as Teams? A Structural Modeling Approach (June 18, 2019). Available at SSRN: https://ssrn.com/abstract=2520188 or http://dx.doi.org/10.2139/ssrn.2520188

Chen Li (Contact Author)

Stan Ross Department of Accountancy, Zicklin School of Business, Baruch College, The City University of New York ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States

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