Corporate Governance, Agency Problems,
and Executive Compensation
Chapter 1 explored the magnitude and structure of executive compensation. It was noted that current CEO compensation for those at the helms of the largest firms, the S&P 500, is approximately $11 million per year, typically composed of a variety of compensation forms: salary, annual bonus, multiyear bonus plans, restricted stock, executive stock options (ESOs), pension benefits, retirement plans, and various perquisites that pertain during and after the CEO’s time with the firm.
In the United States, and in most corporations around the world, corporate charters and the laws of the jurisdictions that allow firms to incorporate assign broad responsibilities of corporate governance to boards of directors. Almost universally, corporate boards have the responsibility to hire, compensate, manage, and dismiss the executives of the firm, including the CEO.
In the dominant understanding of the nature of the corporation, the shareholders own the firm, and the corporation’s board has the task of managing the firm for the benefit of those owners. However, the very idea of shareholder ownership is stoutly denied by many specialists in corporate governance, while vigorously defended by others.1 Nonetheless, the literature on corporate governance and executive compensation has developed over the last 20 years predominately within a framework that views shareholders as owning the firm and acting as principals who retain boards of directors and senior executives as their agents. This, in crudest summary, is the agency theory of the firm, and it is particularly dominant in the finance literature: Shareholders own the firm and act as principals to retain managers to act as their agents and operate the firm on the behalf of the owners. Under this model, shareholders charge corporate boards with the general oversight of the firm. One of the board’s key duties is to