Executive Stock Ownership: The Solution to the Executive Compensation Crisis

Abstract

These results illustrate that when managers with below-equilibrium equity ownership are required to increase their ownership levels, there are improvements in firm performance. John E. Core, professor of accounting, Wharton School, University of Pennsylvania, and David F. Larcker, professor of accounting, Graduate School of Business, Stanford University A basic assumption of executive compensation – that more stock ownership is better than less – is as solid as the theory that supports it. The theory is that companies flourish if their executives act like owners rather than hired hands. If the executives own only a small amount of stock in the company, their self-interest may be paramount and not completely aligned with the interests of the shareholders. However, we also need to factor in the desire of executives to have a balanced personal portfolio. Companies use a number of techniques, such as stock options and cash incentives, to push executives to “act” like owners. However, companies can make them actual owners through stock ownership. But does executive ownership really work? And how does a company get its executives to take on the added risk of owning high levels of stock in the company? Agency theory and costs In 1932, Adolph Berle and Gardiner Means articulated for the first time “agency theory” and its implication for corporate America. This theory describes the conflicts of interest or gaps that naturally occur between economic principals (typically, owners and shareholders) and their agents who run the organizations (typically, employees or executives).