Executive Remuneration

Abstract

In this paper we examine the factors affecting the structure of executives' compensation packages. We focus particularly on the role of various types of delayed compensation as means of bonding executives to their firms. The basic problem is to design a compensation package that rewards actions that are in the long-run interest of the stockholders. Firms must take into account their ability to discern unfortunate circumstances from mismanagement, the extent to which a compensation package forces the executive to face risks beyond his control, and the willingness of a given executive to bear this risk. We use our theory to interpret some executive compensation data from the early 1970s. mental midget can tell whether top management deserves a bonus based on current profits. It is much harder to figure out whether top management has positioned the company well for the long [18]. RECENTLY, EXECUTIVE INCENTIVE STRUCTURES have become a matter of public concern. The comments in a New York Times article entitled Overhauling America's Business Management are typical: managers are too worried about short term profits ... A lot of American companies know they have old machines ... But the manager figures he'll keep the old machines as long as they still run, make a big profit one year, and take that record as an advertisement to get a job elsewhere, [10, p. 17]. Such inappropriate incentives are often linked to the productivity crisis. Clearly, it is in the interest of firms that their managers be concerned with long run profits. Frequently, however, the long run implications of an executive's job performance cannot be assessed until after the executive has terminated his relationship with the company. To relate an executive's reward more closely to his performance, firms can delay a large component of compensation until better information is available, so that the amount of remuneration becomes dependent upon indicators of performance. In this paper, we examine the various factors affecting the structure of executives' compensation packages. Our primary focus is on the role of various types of delayed compensation as means of bonding executives to their firms. Of course, other factors affect the extent to which delayed compensation is used.