I have been reading Pay Without Performance: The Unfulfilled Promise of Executive Compensation by (Harvard law professor) Lucian Bebchuk and (Boalt law prof) Jesse Fried. Bebchuk and Fried take issue with the standard academic account of executive compensation, which goes something like this: Executive compensation is a classic agency cost problem. Although CEOs and other executives are agents of the corporation and its shareholders, they have incentives to shirk. Indeed, they have incentives to behave opportunistically - i.e., to maximize their own wealth and perks at the expense of their shareholder principals. Accordingly, executive compensation schemes must be designed in ways that constrain shirking and opportunism; in other words, executive compensation schemes should strive to align executives' interests with those of the shareholders. In the literature, this usually leads to a recommendation of some sort of performance-based pay scheme, typically entailing the use of stock options.
Bebchuk and Fried do a good job of explaining why executive compensation schemes fail adequately to align managerial and shareholder interests. In brief, they make the very sensible point that managerial influence over the board of directors taints the process by which executive compensation is set. In other words, the system by which agency costs are to be checked is itself tainted by an agency cost problem.
I get off the boat, however, when it comes to the solution. Bebchuk and Fried want to displace the time-tested corporate governance system of director primacy with an untested new system based on shareholder primacy. As regular readers of my academic work know, this is anathema in my book. (See, e.g., Director v. Shareholder Primacy in the Convergence Debate. I'm writing a review of their book for the Texas Law Review, which will focus on this point, and which should be available on my scholarship web site in a month or two.)
Having said that, however, Bebchuk and Fried are to be praised for having written a book that makes highly technical doctrinal and economic analysis accessible to the educated lay reader, while not dumbing down some very sophisticated analysis. As a result, the book remains useful to the specialist as well. It is definitely a book that anyone interested in corporate governance and executive compensation ought to own.
