Agency Costs and Compensation Issues

1
Agency Costs and Compensation Issues

• Incentives and Monitoring Costs

2
Principal - Agent problems

• Agency theory - owners vs. managers
• profit maximization v. utility maximization
• Incentives matter
• Information gathering (monitoring) is costly
• Enforcement is costly
• Two big categories of agency problems
• Adverse selection
• Moral hazard

3
Principal - Agent problems

• Adverse selection Moral hazard Problems
• Adverse Selection - pre-contractual problem
• who is attracted to the contract do we have
  the right people on the bus?
• cat guarding the henhouse
• Moral Hazard - post-contractual problem
• behavior after contractual arrangement
• Insurance problems, particularly

4
Relation to Employee Pay

• Who monitors? How effectively?
• Performance pay issues
• What motivates people?
• Interdependency problems Individual vs. group
• Controllability
• Alignment problems
• Attraction and Retention issues
• Results?
• mixed although more work is being done
• long term company performance improvement?
• Link to company strategy?

5
Relation to Executive Pay

• Who monitors the CEO? How effectively?
• What motivates the CEO?
• Performance pay - base salary
• cash bonus
• stock and stock options
• an amazing variety of detailed plans
• Overall Results?
• mixed -- link to stated goals
• long term company performance improvement?

6
The Art of War Sun Tzu on evaluating
organizations

• Which of the commanders is most imbued with
  Moral Law so that the people are in accord with
  their ruler?
• Which of the commanders most stands for wisdom,
  sincerity, benevolence, courage and strictness?
• In which army is there the most absolute
  certainty that merit will be properly rewarded
  and misdeeds summarily punished?

7
Alternative compensation concepts, theories and
views

• Marginal Productivity
• Opportunity Cost
• Tournament models
• Relative pay and social status
• role of compensation consultants Do consultants
  act as cartel managers?