Managerial Power and Rent Extraction in the Design of Executive Compensation

This paper develops an account of the role and significance of managerial power and rent extraction in executive compensation.Under the optimal contracting approach to executive compensation, which has dominated academic re-search on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value.In contrast, the managerial power approach suggests that boards do not operate at arm's length in devising executive compensation arrangements; rather, executives have power to influence their own pay, and they use that power to extract rents.Furthermore, the desire to camouflage rent extraction might lead to the use of inefficient pay arrangements that provide suboptimal…