Reappraising the Problem of CEO Compensation: Modern and Old Theoretical Perspectives

Abstract

CEO compensation is a controversial issue. In recent decades, the mainstream theory of corporate governance has failed to produce a convincing explanation of the factors that shape the CEO compensation process, which, according to managerial power theory, is largely determined by the CEO’s discretionary power. These problems are increasing in the era of corporate social responsibility. This article’s objective is to show that we can better understand the problem of CEO compensation by reconsidering the various contributions of older research that focused on uncertainty and entrepreneurial action on the one hand and on industrial sabotage and reasonable values on the other. This objective is a prerequisite to rethinking CEO compensation in relation to the challenges of modern production, to the necessary development of an industrial democracy in our market societies, and to constructing a solid theoretical basis from which to reconsider CEO compensation in relation to the true mission of CEOs and to a normative vision for reform. Thus, this article provides theoretical and conceptual bases for a renewed academic debate that will allow for explanatory progress regarding the understanding of the place that the issue of CEO compensation holds in the emergence of a more just version of capitalism.

Keywords:

• CEO compensation
• entrepreneurial role
• industrial democracy
• managerial power
• old institutionalism

JEL Classification Codes::

• D20
• J30
• L20
• M20

Notes

1 This question is not new, and therefore we understand why this issue has a certain level of importance in reference to the founding debates of modern economics and the development of the arguments regarding the capacity of managers to justify their remuneration. Indeed, while the neoclassical economic model of a firm views the maximization of shareholders’ wealth as the sole responsibility of top management, using incentive mechanisms like stock options or “free shares” to monitor the monitor (which is perfectly rational in a self-interest-oriented way of thinking), this debate also results from the need—even the implicit need—of justifying the accepted opposition between white-collar and blue-collar workers, and the wage differences between occupational groups and stakeholders, which includes the ethical point of view: “The general equilibrium that represents the final outcome is based on a detailed mechanism of an economy that rewards the factors of production according to their contribution to the final output. From this perspective, the CEO’s compensation is determined by the value of his contribution to the firm. A person is justly compensated if his remuneration is neither above nor below the value that he has added to the firm. This is another application of wage determination in a competitive market. If he is paid appropriately and performs his assigned responsibilities for the shareholders, then his firm will remain viable long term, its employees will have job security, its creditors will be repaid, and its consumers and the society at large will be benefited. In this instance there is compatibility of purposes. Thus, the ethics-and profit-oriented behaviors are indistinguishable from one another” (Carr and Valinezhad 1994, 85).

2 Including both accounting-based measures and market-based measures of a firm’s value.

3 This is the eternal question: who monitors the monitor?

4 Of course, this approach to CEO compensation momentarily aligns the interests of shareholders with those of the CEO but means nothing regarding the relative performance of the CEO given the artificial aspect of this alignment. This issue is raised by numerous agency theorists confronted with the dilemma that the link “pay-performance” that stock options should have fed is not well-established (Yermack 1997; Daily, Dalton, and Rajagopalan 2003; Hall and Murphy 2003; Core, Guay. and Larcker 2003; Sanders and Hambrick 2007; Armstrong et al. 2013). Stiglitz advanced that CEO compensation was a classic “heads-I-win-tails-you-lose arrangement” (Stiglitz 2003).

5 This helps to perpetuate their business networks and the phenomena of self-reproduction. This logic also applies at the level of associated business institutions.

6 In this regard, the fact that the level of executive compensation, transparency on salaries or, again, the creation of a compensation committee within the company, etc., are now used as corporate “social responsibility” criteria is an interesting and encouraging development.

7 De jure forms of power are central to the internal organization of firms; however, they are now more balanced due to two factors. The financial revolution that has facilitated access to capital ownership makes this form of power less critical. Second, the valuation of specific types of human capital and intangible capital, whose rights of control are not directly contractible and are thus difficult to enforce (see Asher, Mahoney, and Mahoney 2005), are increasingly important for the productive organization and the competitive advantage of the firm. These two structural changes are central to de facto power. De facto power results not from legal mechanisms but from access to critical resources. It is because B is involved in an employment contract and invests in human capital that B has access to the key resources of the collective entity controlled by A; therefore, B has de facto power over A. De facto power is a strong property of “new capitalism.” The reasoning for this phenomenon is as follows. Employees do not have resources other than their specific human capital; therefore, they must be indispensable, productive and effective so that firms can obtain a portion of their power. It is economically more efficient to grant employees access to the critical resources of the collective entity instead of conferring the property rights of these resources to them (see Rajan and Zingales 2001; Chassagnon 2011a and 2011b).

Additional information

Notes on contributors

Benjamin Chapas

Benjamin Chapas is at the Institute of Sustainable Business and Organizations, Confluence: Sciences et Humanités - UCLY, ESDES; IREPE.

Virgile Chassagnon

Virgile Chassagnon is Full Professor at the University Grenoble Alpes in the Department of Economics (CREG) and Director of the Research Institute for the Political Economy of the Firm (IREPE).