Is U.S. CEO Compensation Inefficient Pay Without Performance?

In Pay Without Performance, Professors Lucian Bebchuk and Jesse Fried develop and summarize the leading critiques of current executive compensation practices in the United States. This book, and their highly influential earlier article, Managerial Power and Rent Extraction in the Design of Executive Compensation, with David Walker offer a negative, if mainstream, assessment of the state of U.S. executive compensation: U.S. executive compensation practices are failing in a widespread manner, and much systemic reform is needed. The purpose of our Review is to summarize the book and to offer some counterarguments to try to balance what is becoming an increasingly one-sided debate. The book’s thesis is that executive compensation practices in the U.S. benefit corporate executives at the expense of shareholders through implicit and explicit corruption of the pay-setting process. It argues that CEO employment contracts are bad for shareholders (not “optimal”) because they are the product of managerial power. Managerial power arises, the authors claim, because boards of directors at public companies are beholden to the firm’s top executives, largely due to management’s control over the director nomination process. Weak compensation committees thus do little to protect the firm in its pay negotiations with the CEO, leading to levels of executive pay that are both inappropriately high and have inappropriately low levels of incentives. The only constraint on this process is “outrage,” either among the firm’s shareholders or the general public. This outrage constraint, however, only polices extreme cases of executive overcompensation.