The Group Dynamics Theory of Executive Compensation
77 Pages Posted: 15 Sep 2006
Date Written: September 13, 2006
The corporate governance debate has focused recently on executive compensation. While defenders of the status quo assert that CEO compensation - and corporate governance generally - is efficient, critics contend that boards have been captured by powerful CEOs who demand excessive pay unconditioned on their performance. Both sides argue that the evidence garnered from CEO compensation justifies their positions on legal reform of corporate governance as a whole. Defenders of the status quo argue that the system works well as is, as demonstrated by the enormous success of U.S. corporations. Critics concerned about managerial power propose reforms that will increase board's responsiveness to shareholders, enhancing the board's willingness to act as a check against untrammeled CEO power. In this Article, I take as given that many forms of CEO compensation are less effective than they might be and explore an alternative explanation. Advancing a new, Group Dynamics Theory, I argue that the problems with CEO compensation in public corporations may be caused by the decision-making flaws rooted in group dynamics, particularly groupthink and social cascades. Psychology, rather than economics, may be chiefly to blame. I also propose a very different type of solution, one that targets and improves boards' decision-making processes.
Keywords: corporate governance, executive compensation, law and economics, behavioral law and economics
JEL Classification: D70, D71, G30, G34, G38, K19, K20, K22, M52
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