BY Lucian Arye Bebchuk and Jesse M. Fried

Abstract


This paper provides an overview of the main theoretical elements and
empirical underpinnings of a “managerial power” approach to executive
compensation. Under this approach, the design of executive compensation is
viewed not only as an instrument for addressing the agency problem between
managers and shareholders but also as part of the agency problem itself.
Boards of publicly traded companies with dispersed ownership, we argue,
cannot be expected to bargain at arm’s length with managers. As a result,
managers wield substantial influence over their own pay arrangements, and
they have an interest in reducing the saliency of the amount of their pay and
the extent to which that pay is de-coupled from managers’ performance. We
show that the managerial power approach can explain many features of the
executive compensation landscape, including ones that many researchers have
long viewed as puzzling. Among other things, we discuss option plan design,
stealth compensation, executive loans, payments to departing executives,
retirement benefits, the use of compensation consultants, and the observed
relationship between CEO power and pay. We also explain how managerial
influence might lead to substantially inefficient arrangements that produce
weak or even perverse incentives.