Premium Essay

Bebchuk

In: Business and Management

Submitted By DTair23
Words 905
Pages 4
Question: Discuss the main charges leveled by Bebchuk and Fried against executive compensation practices in US corporations.
Answer: Bebchuk and Fried (the authors) take the following dual approach to the analysis of executive compensation contracts:
1. That, as designed by the board and shareholders, contracts help alleviate agency problems between managers and shareholders (the “optimal contracting” approach).
2. That they are a part of the agency problem itself (the “managerial power” approach).

While the traditional compensation literature takes the optimal contracting view, it is difficult to see, at least with hindsight, why a competing approach did not exist for some time. After all, no contracts are complete or without side effects. It is somewhat more confounding, when one is provided an overview of the limitations of the optimal contracting approach. Specifically, the authors provide the following challenges to the approach:
A. Faulty logic: If managers need contracts to optimize their behavior as agents, why wouldn’t directors? The optimal contracting approach is based on the simplistic assumption that directors are implicitly good representatives of shareholders.
B. Director incentives: Directors who wish to be elected or re-elected are not likely to be adequately confrontational with the CEO because the CEO ultimately has influence over the director selection process. The hope that directors’ share ownership would lead them to overcome this hurdle is not borne out by the data because directors own too little of the companies on whose boards they serve.
C. Market forces: Under the optimal contracting approach market forces are assumed to keep the players honest and the contracts clean. However, there is substantial evidence of firms insulating themselves from such forces, at least partially.

The immediate counter challenge that presents...

Similar Documents

Premium Essay

To What Extent Do You Think Executive Payment Influence Company's Performance

...To what extent does executive pay influence company performance? Whether there is a relationship between the level of executive pay and company performance is a topic of great interest. The forms of executive pay can be both equity-based compensation which is based on the price of company’s stocks, like stocks and options, and non-equity-based compensation, such as cash compensation- including salary and bonus (Bebchuk & Fried, 2006 ). A company’s performance can be measured by its economic return, in other words, the accounting performance on financial statement (Gulen & Rau, 2009). This essay supports that executive pay may have no significant influence on company performance, because there are some ways that managers can decouple their payments from performance, and this essay will investigate these possible underlying reasons. There are studies examine the relationship between the pay policy and performance, and the results do not support the hypothesis that there is significant link between payment and performance. Kubo (2005) examined this link by investigate a group of Japanese companies and the result showed that companies with high pay-performance sensitivity did not get better performance. Gulen and Rau’s (2009) study on incentive pay also suggested that managerial compensation components such as restricted stock, options and long-term incentive payouts, that are meant to align managerial interests with shareholder value, do not necessarily translate......

Words: 827 - Pages: 4

Premium Essay

Corporate Finance

...To what extent is it true that as a result of agency costs shareholders wealth will not be maximized by corporate management. If so, what actions can shareholders take to correct the situation? As we know that agency costs exists in most corporations since the separation of ownership and management in large businesses. Shareholders are the principals and owners; managers are the stockholders’ agents. The problem is to get between shareholders and managers since they have different objectives. Shareholders’ goals are maximizing firms’ value, managers’ goals are benefit themselves, thus the conflicts rise in the company. In this report through concept of agency costs and analysis that two questions will be discussed. First, to what extent that as a result of agency costs shareholders wealth will not be maximized by corporate management. I will talk the agency costs in the conflict of interest between shareholders and management through analysis and lots of examples. Second I will discuss the actions that shareholders take to reduce the agency costs, and achieve their wealth maximizing. According to Hickman (1996), there are always separation of ownership and management in large businesses. Major corporations may have a large number of shareholder, these shareholders have no way to be actively involved in management so that they hire professional managers to manage the corporations. Shareholders put their money in corporations because they......

Words: 1653 - Pages: 7

Premium Essay

To What Extend Does Executive Pay Influence Company Performance

...To what extend does executive pay influence company performance Whether the executive pay influences the company performance or not? Or, can this high pay affect the decision of investors, motivate their employees and attract the brightest individuals to join? There is no universal answer towards this problem in the past few years. Some experts hold the opinion that the financial incentive is consistent with business performance, while some may argue that there is no relationship between them. This paper will discuss this problem and give some evidence below. There is a prediction raised by Principle-agent theory that directors are more motivated while the performance-pay sensitivity increases (Kubo, 2005). However, after testing this prediction, the results do not support the hypothesis. Conversely, the study suggests that it is hard to improve performance in firms with high financial incentive measures. Moreover, it also points out that executives cannot be motivated by directors’ pay. Overall the results indicate that there is no consistence between financial incentive and business performance. The connections between incentive pay and future stock performance can also reflect this problem, where incentive pay refers to restricted stock, options and other forms of long-term compensation. Cooper, Gulan and Rau (2009) examined whether the long-term performance of a company could be better if incentive pay is in such forms. The study shows that performance of the......

Words: 677 - Pages: 3

Premium Essay

To What Extent Does Executive Pay Influence Company Performance

...the beginning of 1990s, a high level of executive compensation has already been regarded as an effective measure to solve the principal-agent problem within a company, that is, to align the benefit of shareholders and executive managers. It’s believed that the rise in executive pay serves as strong incentives, and conceivably, it could be stronger with a larger sum of money (Jenson, M and Murphy, K). Derived from the previous viewpoints and experiences alike, the current executive compensation usually comprises base salary, performance-based bonus and long-term incentives. The system is supposed to furnish executives not only with a large amount of money, but also some equity-based compensation such as stock options and restricted shares (Bebchuk, L. A. and Fried, J. M. (2006), for the purpose of minimizing the interest conflicts and mitigating agency problem. 3 The loopholes of the current system Unfortunately, under the current context of economy, several loopholes are exposed and...

Words: 568 - Pages: 3

Premium Essay

Business

...To what extent does executive pay influence company performance? There has been widespread controversy in recent years about the amount of compensation CEO’s receive. CEO’s financial compensation packages were largely structured to incentivize risk taking in order to increase shareholder wealth (“Restraints on Executive Pay”, 2009). Yet, the 2008 financial crisis was mostly characterized by declining levels of company performance largely due to the increase of risk afforded to CEO’s by the attractiveness of lucrative executive incentives to perform. This essay argues that executive pay and its influence on company performance is both controversial and complex and concludes that executive pay has minimal influence on company performance and, when it does have influence, it tends to be negative. It is widely believed that companies and their shareholders suffer from poor performance unless the importance of incentives for executives – most notably through monetary and stock compensation – is realized (Jensen and Murphy 1990). The notion that the level and performance sensitivity of pay affects the quality of managers an organization can attract in a competitive labor market for executives seems, on the surface, uncontroversial. However, whether compensation policy is truly “one of the most important factors in an organization’s success” (p.139), as Jensen and Murphy (1990) assert needs further examination A series of empirical studies from a variety of industry, national...

Words: 809 - Pages: 4

Premium Essay

Business

...si Question 1 The goal of financial management is to maximize shareholders’ wealth and to minimize agency costs. The following mechanisms have both merits and defects. (a) Executive Share Option Scheme Compared with direct performance evaluation such as sales growth, executive share option scheme is an equity-based compensation, focusing on the corporation’s long-term development. As managers own share options, they will gain from the corporation’s appreciation and bear risks to some extent. Therefore, interests of managers and shareholders become consistent rather than conflicting. For example, Guoco Group Limited announced a new executive share option scheme (ESOS) on 3 November 2011. The new ESOS, with a fresh duration of 10 years, replaces the existing ESOS, which started from 23 January 2006. The purpose of the new ESOS is to align the long-term interests of shareholders with those of eligible executives and to inspire executives to manage the business towards prescribed financial targets, as well as to attract and retain excellent talents. The new ESOS has a longer duration than the existing one and it can be exercised only during one’s employment or directorship. The existing ESOS has made a contribution in the corporation’s growth for the past years. Furthermore, the new ESOS will continuously solve agency problems and stimulate managers to work on the shareholders’ behalf (Guoco Group Ltd. 2011). ESOS will not always be efficient and attractive if it is......

Words: 1310 - Pages: 6

Premium Essay

Short-Termism

...THANH SON, LUONG Student ID: 116181927 MDC individual assignment Short-termism Introduction Short-termism or ‘myopia’ has long been a matter of great controversy. The effects led by this dysfunctional behavior are perceived negatively across all sectors of the economy. This report is going to define and analyze the problem in both theory and real world by the example of Lehman Brothers. Recommendations are also made to mitigate the issue. Overview of the issue In order to last, there is a need for firms to take appropriate actions to secure long-term sustainability. However, the short-term outcomes must not be precluded from consideration, if the firms at least want to survive. Therefore, both long-term and short-term goals need to be equally considered. The most important point is whether the firm can maintain the balance between long-term and short-term. The problem, so called ‘short-termism’ or ‘myopia’, arises when an organization acts in favor of short-term targets at the expense of the long-term (Marginson and Mcaulay, 2008). There are a number of reasons for the occurrence of short-termism. The first reason which causes the issue here is the frequency of financial reporting. More frequent financial reporting is considered as a solution for a more accountable and transparent accounting system. However, this solution leads to another problem for managerial accounting because it pressures companies’ executives to focus more on short-term results, which......

Words: 1520 - Pages: 7

Premium Essay

Compensation and Benefit

...Title: Management Name: Institution: Performance pay also called merit pay can be defined as a system that remunerates its employees in relation to an assessment of individual performance and how well one works. Such systems basically are meant to align employees’ individual effort to the goals and objectives of the organization. Hence it is a reward to individual employees whose tasks have been considered to be above the set standards of an organization or above average. In cases and situations where the output produced or sales produced by an employee are hard or difficult to be empirically determined, performance pay is most applicable; for examples in the teaching profession. In cases of performance payment, individual performance is usually reviewed regularly through a process called performance appraisal. Performance appraisal helps in establishing and identifying if the set objectives and standards are in line with the performance results. Generally, performance pay is usually rewarded on basis of performance results rather than on the time worked, (Council, 2011). Performance pay for teachers has been quite a subject of contention in many places and especially in the USA. Performance pay is meant to compensate teachers based on a set of performance standard and does not consider a teacher’s level of education or the level of experience gained. Hence, the more outstanding results a teacher produces from the students, the more the teacher is to be paid.......

Words: 1560 - Pages: 7

Premium Essay

Micheal

...Is CEO Power Bad? E. Han Kim and Yao Lu1 Abstract Recent evidence suggests that CEO power reduces shareholder value and the efficacy of incentive pay systems. To better understand how the power affects firm governance and performance, we decompose CEO power into three dimensions--structural, ability based, and ownership related. While structural power is indeed harmful--it is associated with higher managerial entrenchment, lower pay for performance sensitivity (PPS), and weaker firm performance--its impact on firm performance is benign when CEO power is restrained by strong external governance mechanisms. Concentration of ability based power in CEO appears to enhance firm performance, but only when external governance is strong. CEO share ownership (as independent variable) shows a U-shaped relation with entrenchment, and -shaped relations with PPS and performance. These results imply that ownership power arising at a high level of share ownership negates the beneficial effects of aligning CEO-shareholder interests through cash flow rights. November 10, 2008 JEL classification: G30, G34, J 33, L25, M52,G32, Keywords: CEO power, managerial entrenchment, Pay for Performance Sensitivity, Firm performance, Share ownership, CEO Centrality 1 Both are at Ross School of Business, University of Michigan, Ann Arbor, Michigan 48109. Email: ehkim@umich.edu and yaolu@umich.edu. We have benefitted from helpful comments and suggestions from Sugato Bhattacharyya, Amy Dittmar,......

Words: 17348 - Pages: 70

Premium Essay

To What Extent Does Executive Pay Influence Company Performance?

...There has been widespread controversy in recent years about the amount of compensation CEO’s receive. CEO’s financial compensation packages were largely structured to incentivize risk taking in order to increase shareholder wealth (“Restraints on Executive Pay”, 2009). Yet, the 2008 financial crisis was mostly characterized by declining levels of company performance largely due to the increase of risk afforded to CEO’s by the attractiveness of lucrative executive incentives to perform. This essay argues that executive pay and its influence on company performance is both controversial and complex and concludes that executive pay has minimal influence on company performance and, when it does have influence, it tends to be negative.    It is widely believed that companies and their shareholders suffer from poor performance unless the importance of incentives for executives – most notably through monetary and stock compensation – is realized (Jensen and Murphy 1990). The notion that the level and performance sensitivity of pay affects the quality of managers an organization can attract in a competitive labor market for executives seems, on the surface, uncontroversial. However, whether compensation policy is truly “one of the most important factors in an organization’s success” (p.139), as Jensen and Murphy (1990) assert needs further examination A series of empirical studies from a variety of industry, national, and time settings present evidence contrary to the......

Words: 655 - Pages: 3

Premium Essay

Shareholder Empowerment

...Introduction: Shareholder empowerment in Malaysia Presently, Shareholders of public companies in Malaysia have limited power in making corporate decision. The precise scope of the powers of each organ is defined by the company’s articles of association, general principles of company law and the Companies Act 1965. Directors usually have the power to manage the business of the company, with the members being entitled to vote only on limited matters expressly reserved to them by the articles of association or the Companies Act 1965. Although they are granted the rights to make decision on the management board and the approval rights in passing directors’ proposals, some shareholders find it inadequate as the current approval rights is a fairly weak tool in controlling agency problem. With wide and in-depth coverage of ongoing corporate tussles, shareholder awareness has improved to the point that shareholders now want to hold management accountable to proper corporate governance. Hence, in this essay, the issue of whether Malaysia should encourage shareholder empowerment to improve corporate governance in companies and thereby attract more foreign direct investment is discussed. To support my arguments three main decision-making power; rules-of the-game, game-ending and scaling-down; as well as the approval rights and proposal rights are discussed. Definition of Shareholder empowerment Shareholder empowerment means the increasing rights given to shareholder to......

Words: 2699 - Pages: 11

Free Essay

Hrm 450 Term Project

...كـليـة إدارة الأعــمـال College of Business Administration Written by: Abdalaziz Saad Alamry ID number: JAB083 Course code: HRM 450 Section number: (1) Subject: Research on “Is Executive Compensation Fair?” Is Executive Compensation Fair? Executive pay (also executive compensation), is financial compensation received by an officer of a firm. It is typically a mixture of salary, bonuses, shares of and/or call options on the company stock, benefits, and perquisites, ideally configured to take into account government regulations, tax law, the desires of the organization and the executive, and rewards for performance. Over the past three decades, executive pay has risen dramatically relative to that of an average worker's wage in the United States, and to a lesser extent in some other countries. Observers differ as to whether this rise is a natural and beneficial result of competition for scarce business talent that can add greatly to stockholder value in large companies, or a socially harmful phenomenon brought about by social and political changes that have given executives greater control over their own pay. Executive pay is an important part of corporate governance, and is often determined by a company's board of directors. Types of compensation There are six basic tools of compensation or remuneration. * salary * short term incentives (STIs), sometimes known as bonuses * long-term incentive plans (LTIP) * employee benefits *......

Words: 3148 - Pages: 13

Premium Essay

Aaabbccdd

...3—Summer 2003—Pages 71–92 Executive Compensation as an Agency Problem Lucian Arye Bebchuk and Jesse M. Fried E xecutive compensation has long attracted a great deal of attention from financial economists. Indeed, the increase in academic papers on the subject of CEO compensation during the 1990s seems to have outpaced even the remarkable increase in CEO pay itself during this period (Murphy, 1999). Much research has focused on how executive compensation schemes can help alleviate the agency problem in publicly traded companies. To understand adequately the landscape of executive compensation, however, one must recognize that the design of compensation arrangements is also partly a product of this same agency problem. Alternative Approaches to Executive Compensation Our focus in this paper is on publicly traded companies without a controlling shareholder. When ownership and management are separated in this way, managers might have substantial power. This recognition goes back, of course, to Berle and Means (1932, p. 139) who observed that top corporate executives, “while in office, have almost complete discretion in management.” Since Jensen and Meckling (1976), the problem of managerial power and discretion has been analyzed in modern finance as an “agency problem.” Managers may use their discretion to benefit themselves personally in a variety y Lucian Arye Bebchuk is the William J. Friedman Professor of Law, Economics and Finance, Harvard Law......

Words: 17317 - Pages: 70

Premium Essay

Using Examples Explore the Difference Between Swm and Sm

...Corporate governance in its simplest classification is “the system by which companies are directed and controlled” (Cadbury, A. 2002). Various theories have been proposed regarding the best method of corporate governance, which have led to the development of two key forms of management goals – shareholder wealth maximisation and stakeholder capitalism. This essay will seek to evaluate the distinctions between these two forms of corporate governance. The shareholder and wealth maximisation (SWM) principle states that the immediate operating goal and ultimate purpose of a public corporation should be to maximize return on equity capital. This perspective views corporate social responsibility as an inappropriate wealth decreasing altruism unless it yields future positive returns for the firm (Windsor, D., & Boatright, J. R. 2010). Prominent in Anglo-American markets, SWM is based on the premise that management are appointed as the agent of the shareholders, therefore having a fiduciary duty to run the company for their benefit (Jensen, M. & Meckling, W.1976). The theory is further underpinned by the assumption that the stock market is efficient, meaning that the share price is always correct; as such share prices are deemed the best allocators of capital (CORE TEXT BOOK). The stock markets constant thirst for positive quarterly financial reports filters down to management level as failure to post favourable results can lead to dismissal; such is the nature of equity......

Words: 1052 - Pages: 5

Free Essay

Executive Compensation

...Regulation of Executive Compensation and its impact on the stability of the financial system | | Introduction In corporate circles, the financial crisis and its effect on companies is sometimes illustrated as a systematic phenomenon in which there is no individual responsibility. Public discussion, on the contrary often assigns the blame of the crisis to bankers or managers, and suggests conclusions of salary reductions or individual liability in terms of losses. In this paper the implications of executive compensation surrounding the financial crisis will be debated. Firstly, the types of executive compensation will be discussed and the implications of them. Secondly, how executive compensation contributed to the financial crisis will be conferred and thirdly the legal improvements and current process will be analysed. To aid understanding, articles and examples will be used to emphasise the various views of economists regarding executive compensation. Non-Regulation of Executive Compensation Executive Compensation can be described as the monetary bonus, or the non-monetary benefits which an executive receives for their work in an organisation. Executive Compensation can be a highly motivating incentive to work more efficiently, thus benefiting the organisation and keeping the executive content with his contribution and performance. However, this compensation can have adverse effects where the executive does not have the organisations best interest in mind,......

Words: 2530 - Pages: 11