Investing
executive compensation, board dependence and managerial influence
The authors argue that making directors independent of executives fails if directors remain insulated from shareholders. Directors must also depend on shareholders, for example by letting owners actually change who sits on the board. Only then, they argue, will directors keep investors' interests in mind when setting pay.
The authors argue that when executives effectively control the boards that set their pay, compensation stops being an arm's-length bargain. They see it instead as managers maximizing their own pay. The textbook picture of a rational contract written for shareholders breaks down when the people across the table depend on the person being paid.
In this account, the real ceiling on executive pay is not what best serves owners but how much outsiders will tolerate before they object. The authors call this an 'outrage constraint.' Pay rises until it risks visible public anger, and no further.
The authors argue that competition among firms and shareholders' formal power to intervene are too loose to stop pay from drifting away from what owners would choose. That leaves managers room to extract what economists call inefficient rents.
In this account, boards protected from shareholder discipline by defensive legal arrangements end up beholden to the managers they oversee. Authority drifts from owners to management. Control over management's own pay follows from that shift.
Because outrage is the limit, the authors argue managers gain by camouflaging both how much they are paid and how little it depends on results. Pay is routed through less visible forms, from option plans to retirement benefits. The stealth is itself evidence that the arrangement was not negotiated on the merits.
The authors document executives quietly reducing how sensitive their pay is to performance. This is why a company can trail its rivals while its chief executive gets a multi-million-dollar raise. Pay labeled as an incentive can be designed so that it rarely falls when results do.
On the authors' account, the bigger harm to owners is not that executives are paid too much. It is that the pay structure weakens and bends managers' incentives, including toward misplaced risk-taking. The problem is framed as one of efficiency, not ethics.