Active Agents, Passive Principals: Does High-Powered CEO Compensation Really Improve Incentives
AbstractIn this Paper we use agency theory to study the active role of the CEO in the formulation of corporate strategy. We allow the agent (CEO) to play a role in defining the parameters of the agency problem, in an incomplete contracting model in which the agent can be rewarded based only on financial performance. Contracts can be renegotiated depending on the proposed strategy. We argue that CEOs will have an incentive to propose difficult, ambitious strategies for change. The principal (the shareholders) can mitigate this by pre-committing to pay high compensation regardless of the manager's chosen strategy, and will prefer to do so in times of change. In a less changeable environment, they will prefer to wait and see what strategy is chosen before setting compensation. In some circumstances, they will also prefer, if possible, to pre-commit never to pay high compensation.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3309.
Date of creation: Apr 2002
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Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
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- Julian Franks & Colin Mayer, 2002. "Corporate governance in the UK : contrasted with the US system," CESifo Forum, Ifo Institute for Economic Research at the University of Munich, vol. 3(3), pages 13-22, October.
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