Optimal Executive Compensation vs. Managerial Power: A Review of Lucian Bebchuk and Jesse Fried’s Pay without Performance: The Unfulfilled Promise of Executive Compensation

This essay reviews Bebchuk and Fried’s Pay without Performance: The Unfulfilled Promise of Executive Compensation. Bebchuk and Fried criticize the standard view of executive compensation, in which executives negotiate contracts with shareholders that provide incentives that motivate them to maximize the shareholders’ welfare. In contrast, Bebchuk and Fried argue that executive compensation is more consistent with executives who control their own boards, and who maximize their own compensation subject to an “outrage constraint”. They provide a host of evidence consistent with this alternative viewpoint. The book can be evaluated from both positive and a normative perspectives. From a positive perspective, much of the evidence they present, especially about the camouflage and risk-taking aspects of executive compensation systems, is fairly persuasive. However, from a normative perspective, the book conveys the idea that policy changes can dramatically improve executive compensation systems and consequently overall corporate performance. It is unclear to me how effective in practice are potential reforms designed to achieve such changes likely to be. * Michael S. Weisbach is the Stanley C. and Joan J. Golder Distinguished Chair in Finance at the University of Illinois at Urbana-Champaign and a Research Associate of the National Bureau of Economic Research. I would like to thank Lucian Bebchuk and Jesse Fried, as well as Roger Gordon, for a number of useful suggestions. In addition, many thanks go to Ben Hermalin for his substantial comments, and more importantly, for his influence on my views on corporate governance that are reflected throughout this review. Contact information: 340 Wohlers Hall, 1206 S. Sixth St., University of Illinois at Urbana-Champaign, Champaign, IL 61820, email: [email protected].