Managerial Power, Stock-Based Incentives, and Firm Performance

Abstract

This paper studies the relation between managerial power, the manager's compensation contract, and firm performance when the manager's contract comprises a stock-based pay and a fixed salary. When there is no cap on the manager's salary, the size of the manager's stock-based compensation is the same regardless of managerial power, and the salary is used as a channel for rent extraction by the manager. This implies that managerial power does not lead to a distortion in efficiency, but only results in wealth transfer from shareholders to managers. Thus firm performance gross of management compensation is independent of managerial power, although firm performance net of management compensation decreases in managerial power. When there is a binding cap on the manager's salary, the manager's stock-based compensation increases in managerial power. Overall, managerial power weakly improves the manager's work incentives but at the cost to outside shareholders due to rent extraction by the manager.