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The Firm DividedManager-Shareholder Conflict and the Fight for Control of the Modern Corporation$
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Graeme Guthrie

Print publication date: 2017

Print ISBN-13: 9780190641184

Published to Oxford Scholarship Online: May 2017

DOI: 10.1093/acprof:oso/9780190641184.001.0001

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A primer on pay

A primer on pay

Executive Compensation and Efficient Contracting

(p.58) Chapter 5 A primer on pay
The Firm Divided

Graeme Guthrie

Oxford University Press

One of a board’s most important roles is setting executive pay. This chapter introduces the various components of executive compensation schemes and analyzes the pay-setting process using the efficient contracting hypothesis. Executives and the board bargain over how sensitive pay will be to the firm’s performance, weighing the incentives generated by performance-based pay against the misallocation of risk that results when risk that could be diversified away by shareholders is transferred onto a firm’s executives. Executives and the board also negotiate over the level of pay, leading to outcomes that reflect the strength or weakness of the board. This chapter uses the story of Michael Eisner’s compensation during the 21 years he was Disney’s CEO to explain the efficient contracting hypothesis and to illustrate the problems that can arise when executives’ compensation is closely tied to a firm’s performance.

Keywords:   incentives, executive compensation, efficient contracting hypothesis, competitive talent markets, short-termism, performance-based pay, executive stock options, measuring compensation

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