Academic journal article Administrative Science Quarterly

The Decoupling of CEO Pay and Performance: An Agency Theory Perspective

Academic journal article Administrative Science Quarterly

The Decoupling of CEO Pay and Performance: An Agency Theory Perspective

Article excerpt

The Decoupling of CEO Pay and Performance: An Agency Theory Perspective This paper examines the extent to which monitoring and incentive alignment of Chief Executive (CEO) compensation and influence patterns of various actors on CEO pay vary as a function of ownership distribution within the firm. Based on the reports of 175 chief compensation officers in manufacturing, it was found that the level of monitoring and incentive alignment was greater in owner-controlled than management-controlled firms. For both types of firms, there was a direct relationship between monitoring and the risk level to the CEO of annual bonuses and long-term income, although the relationship was stronger among owner-controlled firms. In the owner-controlled firms, there was more influence over CEO pay by major stockholders and boards of directors. In management-controlled firms, the CEO pay influence was separated from major stockholders and boards. The results suggest that a behavioral approach to measuring agency theory concepts can provide some new insights into the process used to determine CEO pay.

In recent years there has been considerable disagreement about whether the structure of CEO compensation in large firms is designed so that executive decision making is directed toward maximizing firm performance (e.g., Kerr and Bettis, 1987; Finkelstein and Hambrick, 1988). The question would be moot if traditional market-based models of economics were applicable in which it is assumed that the manager and owner are the same person. This owner-manager bears the risks of decisions and receives the rewards of success (Marris, 1964). However, in the largest business firms in the United States, there is a separation of ownership from control. Owners make virtually no decisions about the operation of the firm. These are left to the management, which has the fiduciary responsibility to act in the interests of shareholders.

A large literature on managerial capitalism has been concerned with these issues for more than half a century. Berle and Means (1932) argued that while stockholders had legal control of large U.S. corporations, it was management, in fact, that exercised effective control. As holdings in large firms became more and more dispersed, communication and concerted action among them became increasingly difficult. Lacking individual influence and having claims on a very small fraction of the corporation, atomistic owners became far removed from corporate policy and decision making. While the board of directors is presumed to represent stockholders and has formal power over management, top executives play a major role in appointing the board and frequently use the board as a vehicle to legitimize decisions that may not be in the best interest of owners (e.g., Galbraith, 1967; Mace, 1971; Allen, 1974; Herman, 1981). Not being subject to external constraints, managers have broad discretion to pursue their own objectives, even when these come into conflict with those of stockholders (Marris, 1964; Williamson, 1964; Monsen and Downs, 1965). For example, increasing sales (Baumol, 1967; Galbraith, 1967) or corporate diversification through mergers and acquisitions (Kroll, Simmons, and Wright, 1989) may be vigorously pursued by management at the expense of profitability and to justify higher executive pay.

For very large firms, the percentage of stock required for an external party to exercise significant control may be quite small (McEachern, 1975; Salamon and Smith, 1979; Salancik and Pfeffer, 1980; Gomez-Mejia, Tosi, and Hinkin, 1987; Kroll, Simmons, and Wright, 1989). Managers appear to behave differently when there is a single equity holder who controls as little as 5 percent of the voting stock (e.g., Boudreaux, 1973; Palmer, 1973; Gomez-Mejia, Tosi, and Hinkin, 1987). These firms are called owner-controlled. When there is no equity holder with at least 5 percent of the stock, the firm is called a management-controlled firm. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.