As previously reported, I am reading with great interest Lucian Bebchuk's and Jesse Fried's book Pay Without Performance, which is a damning critique of executive compensation. I find much of their argument plausible and even persuasive, but I also think they overstate the case a bit.
Their analysis is premised on what they call "managerial power," which claims that management controls the mechanism by which its own pay is set. Hence, they argue, executive compensation fails to align managerial interests with those of shareholders. Although this claim seems true with respect to some types of compensation at some companies some of the time, there is evidence to the contrary. For example, the latest issue of the Economist reports on an interesting study of executive perks:
Raghuram Rajan, the IMF's chief economist, and Julie Wulf, of the Wharton School, looked at how more than 300 big companies dished out perks to their executives in 1986-99. It turns out that neither cash-rich, low-growth firms nor firms with weak governance shower their executives with unusually generous perks. The authors did, however, find evidence to support two competing explanations.
First, firms in the sample with more hierarchical organisations lavished more perks on their executives than firms with flatter structures. Why? Perks are a cheap way to demonstrate status. Just as the armed forces ration medals, firms ration the distribution of conspicuous symbols of corporate status.
Second, perks are a cheap way to boost executive productivity. Firms based in places where it takes a long time to commute are more likely to give the boss a chauffeured limousine. Firms located far from large airports are likelier to lay on a corporate jet.
In other words, executive perks seem to be set with shareholder interests in mind, which tends to undercut the likelihood that managerial power is a unified field theory of executive compensation.
