Executive Compensation As An Agency Problem Finance Essay

All modern organisations have one common characteristic that forms the major separating factor between the direction and the stockholders. In the developed states, big corporations are really composed of a distinguishable construction made up of the stockholders and direction. In fact, the separation of direction and ownership seems to hold gained huge popularity during the start of 20th century. As a consequence of the separation of corporate ownership and direction, the corporate universe has experienced unprecedented growing. On the other manus, separation of ownership and direction has created an addition in struggle between the stockholders and the direction. As a affair of fact, many faculty members and participants in the universe of concern have been attracted to the struggle and even made efforts to suggest diverse mechanisms of deciding them. The conflicting involvement between the stockholders and the direction has been normally referred to as the bureau job.


The motive to research on executive compensation is brought approximately by the desire to keep high degrees of unity and nationalism in the direction while at the same clip guaranting the maximization of shareholders ‘ value. Executive compensation is among the multivariate propositions made by different faculty members and people in the concern universe as a possible solution to the bureau job ( Bebchuk & A ; Fried, 2003 ) . As a tool for the declaration of bureau jobs, executive compensation embraces the creative activity of inducements to the direction. The inducements are seen as a move towards actuating the direction to move in favour of the stockholders. Research into executive compensation as a solution to the bureau jobs is important as it elaborates on the relevancy of executive compensation every bit good as how it can be applied in work outing the bureau jobs. The fact that direction has the authorization to set about diverse determinations that greatly affect the fiscal place of the organisation means that their function is really critical in the house. As such, actuating the direction is viewed as a manner of guaranting that the involvements of the stockholders are considered supreme by the direction whenever determinations are being evaluated. Additionally, the choice of executive compensation as the research subject is due to the contention that is frequently associated with compensation in organisations.

Problem description

In the modern universe of concern, there is ever a separation of the ownership of the concern and the direction. In fact, the proprietors of the business- stockholders are no longer involved in the twenty-four hours to twenty-four hours direction of the concern. The chief functions of the stockholders are to supply capital and elect the board during the AGM. Thereafter, the board appoints the direction squad to transport out the day-to-day operations of the concern. In such companies where the stockholders are non involved in direction, directors possess significant power and find the class that the companies take. Means and Berle ( 1933 ) observed that when managers are in the office, they possess a free discretion in their direction. In modern finance, discretion and the power of direction has been defined to as bureau job ( Balsam, 2002 ) .

The fright that the direction may choose to utilize their managerial discretion to prosecute selfish additions is the major ground for prosecuting in executive compensation. There are a figure of activities into which the direction may acquire involved into whose terminal consequences do non profit the stockholders. For case, imperium edifice is an activity that has an impact of profiting the directors ‘ chase of celebrity. Similarly, it is possible for some directors to keep extra hard currency alternatively of administering it during the times when profitable investings are missing. Furthermore, some directors guarantee that they strongly entrench their places such that throw outing them out of their offices is about impossible. This is peculiarly when the public presentation of such directors is highly hapless ( Bebchuk & A ; Fried, 2003 ) .

In consideration of executive compensation, cardinal struggles of involvement between the stockholders and the direction are considered inexistent. Therefore, two major positions have been considered in the procedure of deciding bureau jobs through executive compensation: attack on optimum power and attack on managerial power ( Balsam, 2002 ) . Most of the fiscal economic experts believe that executive compensation should be viewed through the attack on optimum contracts. Harmonizing to the fiscal economic experts who subscribe to this attack, the agreements yield partial solution to the built-in bureau job. In the attack, the board sets strategies through which the executive is compensated with the chief end of availing executive inducement towards maximization of stockholders wealth. Nevertheless, a figure of defects have been identified with the attack. In fact, the major job has been identified as that there are built-in political restrictions on the extent to which executives can be treated liberally. Therefore, such strategies on compensation do non look high powered in an equal mode ( Jensen & A ; Murphy, 1990 ) .

The attack on managerial power is another manner towards executive compensation. The attack focuses on how the bureau job and executive compensation can be linked together to give better consequences in the maximization of stockholders ‘ wealth. The advocates of this attack are of the position that executive compensation does non merely work out the bureau job but besides that it is itself an bureau job. Through assorted research works, it has been realized that sometimes executive compensation does non ensue to the intended end of supplying inducements to the direction. On the contrary, the compensational efforts have been seen to advance rent seeking by the direction. In consideration of the pros and cons associated executive compensation, there is intense influence from directors on executive compensation.

The design of an executive compensation bundle is extremely influenced by the power possessed by the direction ( Balsam, 2002 ) . Advocates of the catching attack are peculiarly concerned with the extent to which the power of direction determines executive compensation. Additionally, the power of direction has been seen as likely to do significant force per unit area on the stockholders in footings of costs of executive compensation. The excess wage earned by the executives has an impact of deflecting the intended inducement creative activity on the direction and really thining it wholly. As such, the costs merely affect the public presentation of the corporation without any positive alteration on the bureau job.

Executive compensational agreements can be influenced by the prevailing forces in market directed towards maximization of value every bit good as power of direction. As a consequence, the executive compensational agreements depart from prefering the directors merely. However, the power of direction attack holds that the extent of divergence from the maximization of value is extended doing executive compensation unequal agencies of incentive creative activity. The position in the attack towards optimum contract is that sensible extent of agony is experienced by directors in respect to bureau job. Consequently, directors do non ever move in such a manner as to maximise the value of the stockholders ( Jensen & A ; Murphy, 1990 ) . This fact prompts the application diverse mechanism through which inducements can be created to the directors.

There are assorted restrictions as to the application of executive compensation as a manner of incentive creative activity to the direction. Besides the influence that directors have on the execution of executive compensation agreements and the existent of bureau job caused by the managers, it has been realized that sometimes the market forces do non supply sufficient confidence that the result of encompassing optimum contracts will take to successful direction motive into detecting stockholders ‘ involvements. Theoretically, it is hoped that different constructions of the market have the ability to enforce restraints between the determinations of the managers and the demands of the direction ( Jensen & A ; Murphy, 1990 ) . In fact, most of the markets impose less rigorous steps such that significant divergences are experienced. For case, in the instance of coup d’etats, many houses seem slightly hostile towards the acquirer. As a consequence, the acquirer faces huge challenges from the incumbent direction who frequently limits his full control of the house. The ill will is to the hurt of the stockholders as the new acquirer provides better commands to the stockholder. As a consequence, stockholders lose significant wealth.

Formulation of the hypothesis

The hypothesis for this research delves on the relationship between executive compensation and concern public presentation towards the maximization of the stockholders ‘ wealth. In position of the implicit in bureau jobs between the direction and the stockholders, it is imperative to analyse the extent to which executive compensation can assist in the declaration of the job.

Research methodological analysis

Practical cogent evidence on the effectivity of executive compensation in the declaration of the bureau job demand to be established. This can be done through assorted methods such as questionnaires, interviews and observations. Both quantitative and qualitative information demand to be collected. For case, quantitative informations can be collected through questionnaires whereby closed headed questionnaires are used to cognize the figure of executives in support of executive compensation. Similarly, the figure of stockholders in support of executive compensation can be obtained through questionnaires during an AGM. It is besides possible to determine the per centum of stockholder value growing in a scenario with proper executive compensation by associating between different periods when executive compensation had non been implemented. Qualitative informations can besides be obtained through interviews to stockholders on the benefits of executive compensation. In this instance, ARR Corp. is the relevant illustration for the survey.

Clarification of constructs

In this research paper, assorted footings and constructs have been used. Their significances are as follows: Agency job: refers to the struggles that exist between stockholders and the direction in equilibrating the involvements of the shareholders and the selfish chases of the direction ( Balsam, 2002 ) . The 2nd construct is executive compensation which refers to the bundle of wage and benefits allowed to the directors in order to actuate them into set abouting determinations consistent with the involvements of the stockholders. Stockholders are the proprietors of the concern after holding bought portions of the company through a stock exchange. The portions represent the unit of ownership in a public company.


The research is to be organized in signifier of chapters with luxuriant sub-chapters. There will be a tabular array of contents dwelling of the assorted chapters to be covered in the full research. The list of points is as follows: Title page, Copyright, Approval Page, Dedication, Acknowledgements, Abstract, Table of contents, Tables list, Figures List, Body ( Text ) , References, Appendices and Index.