Executive Compensation, Board Functioning, and Corporate Governance

• Author: Alessandro Zattoni,Praveen Kumar
• DOI: http://doi.org/10.1111/corg.12150
• Published date: 01 January 2016
• Date: 01 January 2016

Editorial

Executive Compensation, Board Functioning, and

Corporate Governance

Praveen Kumar and Alessandro Zattoni

Executive compensation has become a major issue in the

corporate governance (CG) literature. The explosive

increase of executive compensation in the US since the early

1980s, especially with respect to equity-based compensation

(e.g., Gabaix & Landier, 2008), has attracted considerable

public scrutinyand the multidisciplinaryattention of scholars,

and differences among countries with respect to executive

compensation practices and levels have been widely studied

(e.g., Boyd, Franco Santos, & Shen, 2012; Ezzamel & Watson,

1998; Zattoni, 2007).

There are a number of frameworks in the literature regard-

ing executivecompensation (Zattoni & Minichilli,2009). Some

economists forward the eff‌iciency hypothesis that views

executive compensation as being optimally designed from

the perspective of shareholder value (Gabaix & Landier,

2008; Rosen, 1992). On the other hand, CG scholars often

adopt agency and managerial power perspectives that view the

increasing deviation of executive and average worker

compensation in manycountries as a sign of corporate gover-

nance failure or malfeasance (Bebchuk & Fried, 2004; Cyert,

Kang, & Kumar, 2002). In particular, the CG perspective

implicates managerial entrenchment (see, e.g., Kumar &

Zattoni, 2014a) coupled with ineffective board performance

(Kumar & Zattoni, 2014b) as facilitating rent extraction by

powerful executives(e.g., Sun & Shin, 2014). Meanwhile,insti-

tutional perspectives on executive compensation emphasize

the role of external forces such as social conformity and social

prestige in the determination of executive compensation

(Belliveau, O’Reilly, & Wade, 1996; Zajac & Westphal, 1995).

Finally, the upper echelon perspective has also helped

generate veryimportant insights, for exampleby emphasizing

that top management team (TMT) aggregate pay levels and

dispersion can impact strategy and f‌irm performance

(Geletkanycz & Sanders, 2012).

Of course, a number of important issues regarding

executive compensation remain open. In particular, the role

of boards in the executive compensation process requires

much attention research. Under the eff‌iciency hypothesis,

boards play no substantive role as it is already assumed that

executive compensation maximizes shareholder welfare. But

the information generation, monitoring, and contract-setting

(with executives) functions of theboard become quite relevant

under the agencyand institutional perspectives.However, the

early agency literature on executive compensation did not

explicitly consider the relation of various board functions to

compensation. It was essentially assumed that the board

represented the shareholders as principals. Subsequently, the

literature explicitly recognized the self-interest and agenda

of the board, setting up a “hierarchical agency”problem with

conf‌licts of interest between managers and shareholders and

conf‌licts of interest between the board and the shareholders

(Cyert et al., 2002; Kumar & Sivaramakrishnan, 2008). Once

the agency problemwith boards is recognized, attentionturns

to the relation of different board functions and executive

compensation. For example, does improved information

generation by boards also help makeexecutive compensation

more incentive-eff‌icient? Do boards with poor monitoring

performance set ineff‌icient executive compensation and, if

so, what form do these ineff‌iciencies take? Do poorly

functioning boards fail to monitor executive manipulation of

the f‌irm’s other important policies (such as investment and

shareholder payouts) to increase compensation?

Recent studies enlarged this view and analyzed other

determinants of executive compensation.For example, Bauer,

Moers, and Viehs (2015) explored the role of institutional

investors’proposals on executive compensation and showed

that they are effective –even when they are retired in

advance of the shareholders meeting –as the negotiation

between investors and the board of directors signif‌icantly

affects pay practices. In addition, recent studies also explore

whether external variables can inf‌luence executive compen-

sation practices and their effects on f‌irm performance. For

example, Sun and Shin (2014) show that contextual factors

like f‌inancial and product market conditions affect board

decision making about offering new stock invectives to top

managers. In addition, Cambini, Rondi, and De Masi (2015)

underline that in energy industries where there is some form

of competition –as a result of market conditions or

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12150

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Corporate Governance: An International Review, 2016, 24(1): 2–4