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Active agents, passive principals; the role of the chief executive in corporate strategy formulation and implementation

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  • Clara Raposo
  • James Dow

Abstract

In this paper we use agency theory to study the active role of the chief executive in the formulation of corporate strategy. Unlike traditional applications of agency theory, we allow the agent (CEO) to play a role in defining the parameters of the agency problem. We argue that CEOs will have an incentive to propose difficult, ambitious strategies for their corporations. The effect arises because in equilibrium, the agent may be overcompensated in the sense that the participation constraint is not binding in determining his compensation. The agent can exploit this by proposing ambitious corporate strategies, thereby influencing the parameters of the constraints in the agency problem. The principal (the owners of the company) can mitigate this by precommitting to pay high compensation regardless of the manager's chosen strategy, but may optimally prefer not to do so.

Suggested Citation

  • Clara Raposo & James Dow, 2000. "Active agents, passive principals; the role of the chief executive in corporate strategy formulation and implementation," OFRC Working Papers Series 2000fe06, Oxford Financial Research Centre.
    • Handle: RePEc:sbs:wpsefe:2000fe06
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2000fe06.pdf
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    JEL classification:

    • 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
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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