Shareholder Evaluation of Public Corporation Executives. An Executive Performance Measure Being an Adequate Basis of a Motivational System

Abstract

The main aim of the paper is determining the most adequate tool which should be applied in public corporations as a basis of motivational systems for executives. The issue is a part of a broader problem of minimizing the agency costs which is of interest in the field of corporate governance. We hold the view that a firm should serve its owners' interests and therefore we also explain in the paper why shareholders' wealth maximization is the best formulation of a company's main objective. In order to achieve the main aim of the paper, first we identify the desirable features of an adequate executive performance measure. These features are: 1) mutual agreement between maximization of the measure and realization of a company's main objective, 2) reflecting in the measure's final value only effects of executives' own decisions. Then we analyze measures currently used in business practice and proposed in the literature, e.g.: Return on Assets (ROA), Return on Equity (ROE), (Cash Flow) Return on Invested Capital (ROIC and CFROIC), Economic Value Added (EVA), Cash Value Added (CVA), Economic Profit (EP), Total Shareholder Return (TSR), from the perspective of possessing the identified features. We conclude that each of the measures has important drawbacks. Trying to overcome them we propose the measure called the Indexed Excess Shareholder Return (XESR) which we find the closest to the ideal. However, we also recognize factors which could diminish its "quality" in practical applications. We emphasize that a motivational system based on an adequate measure is only one - but the most important - corporate governance instrument reducing a threat of executives departing from shareholders' interests. It is worth noticing that a certain construction of a motivational scheme based on XESR is a realization of an indexed executives options idea. We think that particularly interested in a practical application of the XESR should be institutional investors (mainly pension funds). Our analysis - so to say, by the way - proved the great importance of capital markets and a level of their development (mainly efficiency) for reducing the agency costs and, in effect, for more efficient use of scarce resources and an economic growth rate. The other result of the paper is an indirect proof for a real capital markets efficiency based on experience from the Iowa Political Markets.

Keywords: agency theory, agency costs, bonus scheme, company's aim, compensation packages, corporate governance, cost of equity, executives' dismissal, indexed options, managers performance evaluation, motivation, payment, retaining executives, relative performance evaluation

JEL Classification: G14, G23, G34, J33, L21, M52