Active agents, passive principals; the role of the chief executive in corporate strategy formulation and implementation

James Dow and Clara Raposo

No 2000-FE-06, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: In this paper we use agency theory to study the active role of the chief executive in the formulation of corporate strategy. Unlike traditional applications of agency theory, we allow the agent (CEO) to play a role in defining the parameters of the agency problem. We argue that CEOs will have an incentive to propose difficult, ambitious strategies for their corporations. The effect arises because in equilibrium, the agent may be overcompensated in the sense that the participation constraint is not binding in determining his compensation. The agent can exploit this by proposing ambitious corporate strategies, thereby influencing the parameters of the constraints in the agency problem. The principal (the owners of the company) can mitigate this by precommitting to pay high compensation regardless of the manager`s chosen strategy, but may optimally prefer not to do so.

Keywords: agency theory; executive compensation; free-cash-flow theory; strategic complexity (search for similar items in EconPapers)
JEL-codes: D82 G30 G34 J33 (search for similar items in EconPapers)
Date: 2000-10-01
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