Management Accounting Section Midyear Meeting

Are Top Management Teams Compensated as Teams? A Structural Modeling Approach

• In Event: Employees and Teams

Abstract

This paper develops an empirical approach to explicitly test two
multi-agent moral hazard models on executive compensation in the S&P 1500
firms, which distinguish between a team perspective and an individual
perspective. This approach assesses which model is more robust at
rationalizing the observed relationship between executive compensation and
firm performance. The results favor the team perspective under which
unilateral shirking is assumed infeasible for managers. The analysis rejects
the individual perspective under which each manager can unilaterally shirk.
This paper also quantifies three model-based measures of agency costs. The
risk premium can explain up to 37% of total compensation for higher-paid
managers in large firms. This upper bound is higher than that of lower-paid
managers and all managers in small firms. Shareholders could experience a
reduction in asset return by 0.04-0.15 due to managers shirking. In
addition, shareholders could benefit from switching from an
individual--perspective contract to a team--perspective contract. The other
counter-factual analysis predicts that the risk premium could be reduced by
$1-$17 million in the compensation of the higher--paid managers and
$0.1-$3 million in that of the lower-paid managers.

Author

• Chen Li, CUNY-Baruch College