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CEO incentive-based compensation

Investment opportunities and institutional heterogeneity

Written by J. Bonestroo

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Term Paper


Business Administration>Management




Thesis: Agency conflicts and executive compensation In modern companies, the interests of executives (agents) and shareholders (principals) do not necessarily have to be consistent (Jensen & Meckling, 1976). Therefore, executives who have not fully assumed the company's residual debt risk may make investment decisions that detract from the company's value, or pursue their own interests at the expense of shareholders' interests (Jensen & Meckling, 1976; Jensen, 1986). The board of directors that supervises and advises executives on behalf of the company’s stakeholders can use executive compensation to align the interests of the CEO with the interests of shareholders (Jensen & Murphy, 2010). As Holmström (1979; 1982) argues, executives should be rewarded for the company’s ultimate goal (shareholder value), because the principal is unlikely to know exactly which executives’ decisions are value-maximizing. 2 In view of this, the board of directors or remuneration committee should formulate the best executive compensation contract within seconds of information constraints-balancing the best situation for managers who provide incentives and avoid risk or avoid behavior (Frydman & Jenter, 2010; Goergen & Renneboog , 2011). 32.2. Investment opportunities, the United States and executive compensation. Their value comes from growth opportunities rather than existing assets. It is difficult to monitor due to greater information asymmetry and future-oriented decision-making characterized by a higher degree of uncertainty (Smith & Watts, 1992; Kole, 1997).4 In view of this, the agency conflicts of companies with high growth opportunities may be more serious. Therefore, combining executive compensation with long-term stock performance (such as equity-based compensation) can be a mitigation of agency conflicts and Useful mechanisms for expanding management horizons rely heavily on growing companies (Jensen and Murphy, 2010). Previously, based on evidence from different samples, time periods, and estimation methods, the United States partially supported the assumption that companies with higher investment opportunities would pay more CEO compensation based on incentives, especially equity compensation. Smith and Watts (1992), Bryanet al. (2000), Ryan and Wiggins (2001; 2002), and Kang, Kumar, and Lee (2006) show that investment opportunities are positively correlated with equity returns. In addition, Ryan and Wiggins (2001; 2002) and Bryan et al. (2000) show that investment opportunities are positively correlated with stock options and negatively correlated with restricted stocks. On the other hand, Yermack (1995) reported a negative correlation between investment opportunities and stock option returns. Laporta et al. (1998) distinguishes common law from civil law countries based on their legal environment. Common law was spread by colonies (mainly Anglo-Saxon countries), and its legal practice was mainly determined by judges and based on precedent. On the other hand, the civil law extended by French, German, and Scandinavian families is mainly determined by legal scholars and government agencies. We have noticed from LaPorta et al. (1998; 2000; 2002) and La Porta et al. (2008) that common law countries enjoy the highest creditor and shareholder protection, income quality, market valuation, dividend payment, economic Growth and minimum ownership are more concentrated than countries affected by French, Scandinavian, and German ancestry. Therefore, there are good reasons to believe that the salary structure of executives is affected by the legal environment of the country. Therefore, the salaries of executives around the world are different. First, as shown by La Porta et al. (2000), in countries where shareholder protection is stronger, minority shareholders are better protected from the opportunistic behavior of agents. Therefore, in countries with better shareholder protection, companies have a wider range of shareholdings, and the agency conflict between agents and shareholders is aggravated by the lack of supervision of large shareholders (Mehran, 1995). Bryan et al. (2011) and Brenner and Swalbach (2009) believe that in this case, the board of directors and the compensation committee should pay more attention to equity compensation as a link mechanism to align the interests of the agent with the interests of the principal . Secondly, we can think that when a country’s shareholder protection is poor, the stock market has poor liquidity, and the company’s main source of funds is banks or centralized equity providers. Therefore, agency conflicts are likely to change from traditional agency conflicts between principals and debt conflicts between owners or conflicts between minority shareholders and controlling shareholders. A fixed interest is paid to debt providers, so in order to incentivize executives to increase the residual claim rights that can be allocated to company shareholders, risky incentive compensation is not required (Bryan, Nash, and Patel, 2006). Therefore, people with debt in companies with relatively large financing should prefer a larger portion of the fixed salary (Ryan & Wiggins, 2001). In addition, as shown by Mehran (1995), Croci et al. (2012) and De Cesari, Goonec, and Ozkan (2016), controlling owners (such as households) can act as a supervisory mechanism and reduce compensation for incentives or equity-based compensation. Demand. ) Third, as Hölmstrom (1979; 1982) advocated, executives should be paid for the company’s ultimate goal, which is to maximize shareholders. However, Bryan et al. Read Less