Agency Theory Revisited: CEO Return and Shareholder Interest Alignment
Nyberg, A.J., Smithey Fulmer, I., Gerhart, B. and Carpenter, M.A.
- Agency theory: suggests that managerial mischief may occur when the interest s of
owners and managers (agents) diverge.
- A solution is that firms align owner and agent interests through agents’ equity
ownership and the structure of their compensation. Involves 2 components:
o Financial alignment: agent’s economic rewards covary with those of owners
through ownership and/or compensation.
o Alignment of preferences and actions: agent’s preferences become more
aligned with those of owners, and the agent’s choice of actions, though still
motivated by self-interest, are more consistent with owner interests.
- How financial alignment is created may also affect agents’ risk preferences.
- Incentive alignment as an explanatory construct for CEO pay is weakly supported.
- Managerial power dominates the nature of CEO compensation.
- Agency theory may not tell the whole story, but its propositions about alignment
remain an important part of the CEO compensation story.
- The purpose of this study is to provide a view of the CEO incentive alignment
- Sample: 2166 public S&P US firms over a 13-year period.
- The magnitude of the CEO alignment relationship is larger than reported previously.
Theory and hypotheses
- Applied to compensation, agency theory addresses the potential lack of alignment of
goals, preferences, and actions between agents (managers) and principals
- Lack of alignment results in agency costs.
- Three principal means of minimizing agency problems:
o Board independence: improving directors’ monitoring of managers.
o Market for corporate control: active M&A market that disciplines
o Agent equity ownership: leads managers who share ownership of their firm
to embrace shareholder interests.
- Outcome-based contracting is particularly desirable when it is difficult or costly to
monitor an agent’s behavior or to make a priori judgments about the benefit of
- An implicit assumption is that if financial alignment is ‘strong enough’, then
appropriate alignment of preferences and actions will follow.
- We consider financial alignment achieved through equity ownership and other
means, as well as the subsequent consequences of such alignment for shareholders.
Is there financial alignment between CEOs and shareholders?
- There are three key reasons to question the wisdom of broadly dismissing agency
theory on the basis of meta-analytic studies and more recent empirical practices:
o The conclusions that can be drawn from a meta-analysis are limited by the
quality and representativeness of the primary data.