Texas Law Review, Volume 96, Number 2, December 2017 Page: 272
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Texas Law Review
investors.222 Hopefully, the framework of analysis offered in this Article, and
the conclusion it achieves, will prove useful to support this demand, while
also providing policymakers with tangible reasons for reconsidering the
current direction of corporate governance and executive-compensation
policies.
Conclusion
"Managerial power theory"-the view that structural flaws in corporate
governance, such as board defenses, enable managers to extract inefficient
entrenchment rents-has risen to the forefront of the executive-compensation
debate. The executive-compensation reforms that have taken place in recent
years, such as the introduction of say-on-pay shareholder votes, provide
perhaps the clearest evidence of this theory's enormous influence. The
common denominator of such reforms is their attempt to increase shareholder
power vis-a-vis directors, consistent with the central claim of managerial
power scholars that only by empowering shareholders can directors be made
truly accountable and executive-compensation practices be improved.
In spite of having gained the upper hand, managerial power theory
surprisingly lacks robust empirical testing. Equally surprising is the failure
of managerial power scholars to thoroughly confront the currently prevailing
economic paradigm of executive compensation: "managerial talent theory,"
according to which high executive pay reflects compensation for scarce
managerial talent in competitive markets.
This Article remedies these failures, reviewing the main arguments of
managerial power theory both theoretically and empirically and finding them
wanting. Supporting the managerial talent view of executive pay, we
conclude that high executive pay is generally consistent with optimal board
contracting towards the attraction and retention of scarce, talented managers,
rather than with opportunistic rent extraction by managers.
Our study shows that once one incorporates competitive market forces
and the dynamic nature of managerial employment relationships into the
analysis, granting managers high rents emerges as beneficial, rather than
detrimental, to shareholder interests. Indeed, paying managers these rents
helps ensure that a manager's continuation payoff (that is, the expectation of
future compensation) can be "exploited" as a bonding mechanism to commit
the manager to the creation of long-term firm value. There are two reasons.
First, the expectation of high future rents helps offset the potential distortions
that a manager's chances at mobility may introduce in managerial incentive
schemes within a competitive environment. Second, expected high rents
mitigate the short-termist incentives that managers may develop in the
context of dynamic employment relationships, as the prospect of losing these
222. Id. at 1440-41.272
[Vol. 96:205
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Texas Law Review Association. Texas Law Review, Volume 96, Number 2, December 2017, periodical, December 2017; Austin, Texas. (https://texashistory.unt.edu/ark:/67531/metapth1115391/m1/80/?rotate=90: accessed July 18, 2024), University of North Texas Libraries, The Portal to Texas History, https://texashistory.unt.edu; crediting UNT Libraries Government Documents Department.