Executive Compensation in America: Optimal Contracting or Extraction of Rents

Lucian Bebchuk (), Jesse Fried and David I Walker

No 3112, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This Paper develops an account of the role and significance of rent extraction in executive compensation. Under the optimal contracting view of executive compensation, which has dominated academic research on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value by designing an optimal principal-agent contract. Under the alternative rent extraction view that we examine, the board does not operate at arm?s length; rather, executives have power to influence their own compensation, and they use their power to extract rents. As a result, executives are paid more than is optimal for shareholders and, to camouflage the extraction of rents, executive compensation might be structured sub-optimally. The presence of rent extraction, we argue, is consistent both with the processes that produce compensation schemes and with the market forces and constraints that companies face. Examining the large body of empirical work on executive compensation, we show that the picture emerging from it is largely compatible with the rent extraction view. Indeed, rent extraction, and the desire to camouflage it, can better explain many puzzling features of compensation patterns and practices. We conclude that extraction of rents might well play a significant role in US executive compensation; and that the significant presence of rent extraction should be taken into account in any examination of the practice and regulation of corporate governance.

Keywords: Executive compensation; Stock options; Corporate governance; Private benefits of control; Agency costs; Rent extraction (search for similar items in EconPapers)
JEL-codes: D23 G32 G34 G38 J33 J44 K22 (search for similar items in EconPapers)
Date: 2001-12
References: View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Working Paper: Executive Compensation in America: Optimal Contracting or Extraction of Rents? (2001)
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