Blog of Intellectual Capital

An article written by Uwe E. Reinhardt by way of NY times.

“In my previous two posts, I explored what insights might be had from economists on the compensation of American corporate executives. I concluded “not many,” besides theoretical demand-and-supply models based on questionable assumptions.

The decision makers on the demand side of these models are corporate boards elected, in theory, by shareholders. Economists tacitly assume that in their decisions the boards act as faithful representatives of the shareholders. Thus, they are assumed to bargain on behalf of shareholders with management over the compensation of the C.E.O. and other top executives, and to do so in genuinely arms-length negotiations.

In these negotiations, the boards are assumed to structure the compensation of executives so that the economic incentives facing management will be aligned with those of shareholders — an ideal called “optimal contracting” between the principal (shareholders, as represented by the board) and the agent (the executives hired to manage the shareholders’ firm) in this vision of corporate governance.

The question is how well this felicitous principal-agent model of corporate governance conforms to reality.

In their well-researched and cogently argued “Pay Without Performance: The Unfulfilled Promise of Executive Compensation” (Harvard University Press, 2004), Lucian A. Bebchuk and Jesse M. Fried, Harvard and Berkeley law professors, respectively, and experts on corporate governance, take straight aim at the economists’ model. Anyone interested in this topic could not do better than reading this widely praised book, along with the economist Michael S. Weisbach’s thoughtful review of it, published in the Journal of Economic Literature. ”

The whole article can be found at NY Times here.

Also, please see others analysis here: Proxydemocracy, MacIlree,