Hostname: page-component-cd9895bd7-dzt6s Total loading time: 0 Render date: 2024-12-25T20:40:44.744Z Has data issue: false hasContentIssue false
  • English
  • Français

From Hired Hands to Co-Owners: Compensation, Team Production, and the Role of the CEO

Published online by Cambridge University Press:  23 January 2015

John R. Boatright
Get access Rights & Permissions [Opens in a new window]

Abstract:

In the 1990s, the role of the chief executive officer (CEO) of major United States corporations underwent a profound transformation in which CEOs went from being bureaucrats or technocrats to shareholder partisans who acted more like proprietors or entrepreneurs. This transformation occurred in response to changes in the competitive environment of U.S. corporations and also to the agency theory argument that high levels of compensation by means of stock options helped to overcome the agency problem inherent in the separation of ownership and control. Some critics charge that this new CEO role is objectionable for a variety of reasons, which may also be applicable to the current financial crisis in which CEO misconduct may have played a part. These objections are based largely on a team production model of corporate governance, which is held by these critics to be superior to the standard agent-principal model. This article examines the objections offered by critics of the changed role of the CEO and argues that their negative assessment of this development and their use of the team production model to support their conclusions are not warranted. CEOs have changed from hired hands to co-owners, and this change may have contributed in some measure to the current financial crisis. However, in determining the morally preferable role of the CEO, care must be taken not to discard what is sound in the changed role.

Type
Articles
Information
Business Ethics Quarterly , Volume 19 , Issue 4 , October 2009 , pp. 471 - 496
Copyright
Copyright © Society for Business Ethics 2009

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Notes

1. Englander, Ernie and Kaufman, Allen, “The End of Managerial Ideology: From Corporate Social Responsibility to Corporate Social Indifference,” Enterprise and Society 5 (2004): 404–50.CrossRefGoogle Scholar

2. Jensen, Michael C. and Murphy, Kevin J., “CEO Incentives—It's Not How Much You Pay, But How,” Harvard Business Review May-June 1990: 138.Google Scholar

3. Englander and Kaufman, “The End of Managerial Ideology,” 417.

4. Frey, Bruno S. and Osterloh, Margit, “Yes, Managers Should Be Paid Like Bureaucrats,” Journal of Management Inquiry 14 (2005): 96–111.CrossRefGoogle Scholar

5. Blair, Margaret M. and Stout, Lynn A., “A Team Production Theory of Corporate Law,” Virginia Law Review 85 (1999): 247–328.CrossRefGoogle Scholar Englander and Kaufman also apply the team production model of Blair and Stout to the selection and functioning of corporate boards. Kaufman, Allen and Englander, Ernie, “A Team Production Model of Corporate Governance,” Academy of Management Executive 19 (2005): 9–22.Google Scholar

6. For Frey and Osterloh, the application of team production analysis to the CEO and other managers is a feature which they add to the Blair and Stout team production model and which distinguishes their common pool approach from this model. Frey and Osterloh, “Yes, Managers Should Be Paid Like Bureaucrats,” 100.

7. Englander and Kaufman, “The End of Managerial Ideology,” 409–11.

8. Berle, Adolf A. Jr.,, and Means, Gardiner C., The Modern Corporation and Private Property (New York: Macmillan, 1932).Google Scholar

9. Englander and Kaufman, “The End of Managerial Ideology,” 406.

10. Ibid., 410.

11. Lewellen, Wilbur G., Executive Compensation in Large Industrial Corporations (New York: Columbia University Press, 1968).Google Scholar

12. Englander and Kaufman, “The End of Managerial Ideology,” 412; Lewellen, Executive Compensation in Large Industrial Corporations, 211–26.

13. Englander and Kaufman, “The End of Managerial Ideology,” 413–14.

14. Jensen, Michael C., “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,” Journal of Finance 48 (1993): 831–80.CrossRefGoogle Scholar

15. Murphy, Kevin J., “Politics, Economics, and Executive Compensation,” University of Cincinnati Law Review 63 (1995): 713–46, see 718–21.Google Scholar

16. Ibid., 722.

17. Bebchuk, Lucian and Grinstein, Yaniv, “The Growth of Executive Pay,” Oxford Review of Economic Policy 21 (2005): 283–303.CrossRefGoogle Scholar

18. Jensen, Michael C., Murphy, Kevin J., and Wruck, Eric G., “Remuneration: Where We've Been, How We Got Here, What Are the Problems, and How to Fix Them,” Harvard Business School NOM Research Paper No. 04–28 (2004): 25.Google Scholar

19. Hall, Brian J. and Liebman, Jeffrey B., “Are CEOs Really Paid Like Bureaucrats?” Quarterly Journal of Economics 113 (1998): 653–91.CrossRefGoogle Scholar

20. Blair, Margaret M., “CEO Pay: Why Such a Controversy?” Brookings Review 94 (1994): 23–31.Google Scholar

21. The Omnibus Budget Reconciliation Act of 1993 added Section 162(m) to the Internal Revenue Code, which removed the tax deductibility for corporations of salary compensation over $1 million. For its effect, see Rose, Nancy L. and Wolfram, Catherine, “Has the ‘Million Dollar Cap’ Affected CEO Pay?” American Economic Review 90(2) (2000): 197–202;Google Scholar and Hall, Brian J. and Liebman, Jeffrey B., “The Taxation of Executive Compensation,” in Tax Policy and the Economy, vol. 14, ed. Poterba, James (Cambridge, Mass.: NBER & MIT Press, 2000).Google Scholar

22. Hall and Liebman, “Are CEOs Really Paid Like Bureaucrats?” 656.

23. Gabaix, Xavier and Landier, Augustin, “Why Has CEO Pay Increased So Much?” Unpublished Manuscript, January 8, 2007.Google Scholar

24. Zajac and Westphal observe that theory is important symbolically in gaining the acceptance of stock options and the resulting high compensation. They cite both agency theory and human resource justifications as instrumental in securing the acceptability of CEO compensation. Zajac, Edward J. and Westphal, James D., “Accounting for the Explanations of CEO Compensation: Substance and Symbolism,” Administrative Science Quarterly 40 (1995): 283–308.CrossRefGoogle Scholar

25. For the development of the theory of the firm in economics, see Alchian, Armen A. and Demsetz, Harold, “Production, Information Costs, and Economic Organization,” American Economic Review 62 (1972): 777–95;Google ScholarKlein, Benjamin, Crawford, Robert A., and Alchian, Armen A., “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process,” Journal of Law and Economics 21 (1978): 297–326;CrossRefGoogle ScholarJensen, Michael C. and Meckling, William H., “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” Journal of Financial Economics 3 (1983): 305–60;CrossRefGoogle ScholarFama, Eugene F. and Jensen, Michael C., “Separation of Ownership and Control,” Journal of Law and Economics 26 (1983): 301–25;CrossRefGoogle ScholarSteven, N. S. Cheung, “The Contractual Theory of the Firm,” Journal of Law and Economics 26 (1983): 1–22;Google Scholar and Williamson, Oliver E., The Economic Institutions of Capitalism (New York: Free Press, 1985).Google Scholar For the development of this theory in corporate law, see Easterbrook, Frank H. and Fischel, Daniel R., The Economic Structure of Corporate Law (Cambridge, Mass.: Harvard University Press, 1991);Google ScholarKlein, William A., “The Modern Business Organization: Bargaining under Constraints,” Yale Law Journal 91 (1982): 1521–64;CrossRefGoogle ScholarHart, Oliver, “An Economist's Perspective on the Theory of the Firm,” Columbia Law Review 89 (1989): 1757–73;CrossRefGoogle Scholar and Butler, Henry N., “The Contractual Theory of the Firm,” George Mason Law Review 11 (1989): 99–123.Google Scholar

26. Jensen, Murphy, and Wruck, Remuneration, 100.

27. Of course, corporate boards may be mistaken about the cost and effectiveness of stock options as incentives. See Hall, Brian J. and Murphy, Kevin J., “The Trouble with Stock Options,” Journal of Economic Perspectives 17 (2003): 49–70.CrossRefGoogle Scholar Many scholars who accept that CEOs ought to be compensated in ways that provide incentives to increase shareholder wealth nevertheless argue that current compensation practices fail to do this. See Bebchuk, Lucian and Fried, Jesse, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, Mass.: Harvard University Press, 2004).Google Scholar

28. Englander and Kaufman, “The End of Managerial Ideology,” 438.

29. Ibid., 438. Although Englander and Kaufman claim that in the older role, CEOs had a fiduciary duty to non-shareholder constituencies because of a fiduciary duty to the corporation, this fiduciary duty to non-shareholder constituencies is of fairly recent origin and has been held in only a few very narrow instances. However, the general lack of any legal fiduciary duty to non-shareholder constituencies does not mean that executives and directors have no moral and legal non-fiduciary duties to non-shareholder constituencies. See Marens, Richard and Wicks, Andrew, “Getting Real: Stakeholder Theory, Managerial Practice, and the General Irrelevance of Fiduciary Duties Owed to Shareholders,” Business Ethics Quarterly 9 (1999): 273–93.CrossRefGoogle Scholar

30. Schumpeter, Joseph A., Capitalism, Socialism, and Democracy (New York: Harper & Row, 1942).Google Scholar

31. Englander and Kaufman observe that the changes that caused managers to be a special class “fostered a tournament for the CEO title and bestowed on the winner the right to a proprietary fortune” (Englander and Kaufman, “The End of Managerial Ideology,” 432). For discussions of the economics of tournaments in CEO compensation, see Lazear, Edward and Rosen, Sherwin, “Rank-Order Tournaments as Optimum Labor Contracts,” Journal of Political Economy 89 (1981): 841–64;CrossRefGoogle ScholarRosen, Sherwin, “Prizes and Incentives in Elimination Tournaments,” American Economic Review 76 (1986): 701–15;Google Scholar and Charles, A. O'Reilly III, Main, Brian G., and Crystal, Graef S., “CEO Compensation as Tournament and Social Comparison: A Tale of Two Theories,” Administrative Science Quarterly 33 (1988): 257–74.Google Scholar

32. Friedman, Milton, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), 133.Google Scholar Although Englander and Kaufman probably overstate the demise of corporate social responsibility, its acceptance in corporate America has undergone a significant change in which socially responsible activities are undertaken on the grounds that they benefit shareholders. For discussions of the so-called “business case” for CSR, see Vogel, David, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility (Washington, D.C.: The Brookings Institution, 2005);Google Scholar and Smith, Craig N., “Corporate Social Responsibility: Whether or How?” California Management Review 45 (2003): 52–76.CrossRefGoogle Scholar

33. Englander and Kaufman, “The End of Managerial Ideology,” 415. See also Kaufman and Englander, “A Team Production Model of Corporate Governance,” in which the authors argue that the present-day role of the boards, like the present-day role of the CEO, is inefficient and ought to be redesigned in accord with a team production model of the firm.

34. The nirvana fallacy is generally attributed to Demsetz, Harold, “Information and Efficiency: Another Viewpoint,” Journal of Law and Economics 12 (1969): 1–22.CrossRefGoogle Scholar

35. Englander and Kaufman, “The End of Managerial Ideology,” 439.

36. Jensen, Michael C., “Value Maximization, Stakeholder Theory, and the Corporate Objective Function,” Business Ethics Quarterly 12 (2006): 235–56.CrossRefGoogle Scholar

37. Englander and Kaufman, “The End of Managerial Ideology,” 407.

38. Bebchuk and Fried, Pay Without Performance.

39. Frey and Osterloh, “Yes, Managers Should Be Paid Like Bureaucrats,” 99.

40. As Frey and Osterloh note, in addition to the underinvestment of firm-specific assets, the problems in team production to be solved also include free-riding by team members and information asymmetry. Ibid., 99.

41. Ibid., 100.

42. Frey and Osterloh's common pool approach incorporates the team production model but adds the element of prosocial intrinsic motivation to solve the problem of how a CEO can have firm-specific investments and still be a mediating hierarch. Although this added element may strengthen the team production model by solving an alleged problem with it, prosocial intrinsic motivation need not be considered in this article's examination of the team production model. For present purposes, it is the soundness of the team production model—on whose main elements all holders agree—and not of Frey and Osterloh's expanded version that is critical to evaluating the criticism of England and Kaufman and of Frey and Osterloh of the changed CEO role. Thus, in this article, the team production model and the common pool approach are considered as one, and the merits of Frey and Osterloh's account of prosocial intrinsic motivation need not be further considered.

43. Frey and Osterloh cite Shane A. Johnson, Harley E. Ryan, and Yisong S. Tian, “Executive Compensation and Corporate Fraud,” unpublished manuscript (2005).

44. Kaufman and Englander, “A Team Production Model of Corporate Governance,” 9.

45. Piketty, Thomas and Saez, Emmanuel, “Income Inequality in the United States, 1913–1998,” Quarterly Journal of Economics 118 (2003): 1–39;CrossRefGoogle Scholar and Piketty, Thomas and Saez, Emmanuel, “The Evolution of Top Incomes: A Historical and International Perspective,” National Bureau of Economic Research, Working Paper 11955 (2006).Google Scholar

46. Ian, Dew-Becker and Gordon, Robert J., “Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income,” Brookings Panel on Economic Activity, Washington, D.C., September 8–9, 2005.Google Scholar

47. Englander and Kaufman, “The End of Managerial Ideology,” 442.

48. Ibid., 405. See also Kaufman, Allen, Zacharias, Lawrence, and Karson, Marvin, Managers vs. Owners: The Struggle for Corporate Control in American Democracy (New York: Oxford University Press, 1995).Google Scholar

49. Englander and Kaufman, “The End of Managerial Ideology,” 438.

50. Some articles that find a link between compensation and fraud are Harris, Jared and Bromiley, Philip, “Incentives to Cheat: The Influence of Executive Compensation and Firm Performance on Financial Misrepresentation,” Organization Science 18 (2007): 350–67;CrossRefGoogle Scholar and Burns, Natasha and Kedia, Simi, “The Impact of Performance-Based Compensation on Misreporting,” Journal of Financial Economics 79 (2006): 35–67.CrossRefGoogle Scholar Mixed results are reported in O'Connor, Joseph P. Jr.,, Priem, Richard L., Joseph, Coombs E., and Matthew Gilley, K., “Do CEO Stock Options Prevent or Promote Fraudulent Financial Reporting,” Academy of Management Journal 49 (2006): 483–500.CrossRefGoogle Scholar Other researchers find no link between compensation and fraud. See Ericson, Merle, Hanlon, Michelle, and Maydew, Edward, “Is There a Link between Executive Equity Incentives and Accounting Fraud?” Journal of Accounting Research 44 (2006): 113–43.CrossRefGoogle Scholar

51. In addition to Blair and Stout, “A Team Production Theory of Corporate Law,” see also Blair, Margaret M. and Stout, Lynn A., “Corporate Accountability: Director Accountability and the Mediating Role of the Board,” Washington University Law Quarterly 79 (2001): 403–48;Google ScholarBlair, Margaret M. and Stout, Lynn A., “Trust, Trustworthiness, and the Behavioral Norms of Corporate Law,” University of Pennsylvania Law Review 149 (2001): 1735–1810;CrossRefGoogle Scholar and Blair, Margaret M. and Stout, Lynn A., “Team Production in Business Organizations: An Introduction,” Journal of Corporation Law 24 (1999): 743–50.Google Scholar

52. The economic analysis of team production is due primarily to Alchian and Demsetz, “Production, Information Costs, and Economic Organization.” For other contributions, see Holmstrom, Bengt, “Moral Hazard in Teams,” Bell Journal of Economics and Management 13 (1982): 324–40;CrossRefGoogle ScholarAoki, Masahiko, “The Contingent Governance of Teams: Analysis of Institutional Complementarity,” International Economic Review 35 (1994): 657–76;Google Scholar and Rajan, Raghuram G. and Zingales, Luigi, “Power in the Theory of the Firm,” Quarterly Journal of Economics 113 (1998): 387–432.CrossRefGoogle Scholar

53. Coase, Ronald M., “The Nature of the Firm,” Economica, N.S., 4 (1937): 386–405.CrossRefGoogle Scholar

54. Alchian and Demsetz, “Production, Information Costs, and Economic Organization,” 777, 779.

55. Ibid., 782–83.

56. Ibid., 781.

57. Ibid., 781–83.

58. Blair and Stout, “A Team Production Theory of Corporate Law,” 276–78.

59. Ibid., 264, 270.

60. Ibid., 253.

61. Ibid., 250–51, 254.

62. Ibid., 275.

63. Kaufman and Englander, “A Team Production Model of Corporate Governance,” 13.

64. Frey and Osterloh, “Yes, Managers Should Be Paid Like Bureaucrats,” 99.

65. Kostant, Peter C., “Team Production and the Progressive Corporate Law Agenda,” University of California at Davis Law Review 35 (2001–2002): 667–704.Google Scholar See also Mitchell, Lawrence E., ed., Progressive Corporate Law (Boulder, Colo.: Westview Press, 1995);Google Scholar and Greenfield, Kent, The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities (Chicago: University of Chicago Press, 2006).Google Scholar

66. John, C. Coates IV, “Measuring the Domain of Mediating Hierarchy: How Contestable Are U.S. Public Corporations?” Journal of Corporation Law 24 (1998–1999): 837–67;Google ScholarMillon, David, “New Game Plan or Business as Usual? A Critique of the Team Production Model of the Corporate Law,” Virginia Law Review 86 (2000): 1001–44;CrossRefGoogle ScholarMeese, Alan J., “The Team Production Theory of Corporate Law: A Critical Assessment,” William and Mary Law Review 43 (2001–2002): 1629–1702;Google Scholar and Lee, Ian B., “Efficiency and Ethics in the Debate about Shareholder Primacy,” Delaware Journal of Corporate Law 31 (2006): 533–87.Google Scholar

67. See, for example, Macey, Jonathan R., “An Economic Analysis of the Various Rationales for Making Shareholders the Exclusive Beneficiaries of Corporate Fiduciary Duties,” Stetson Law Review 21 (1991): 401–24;Google Scholar and Stout, Lynn A., “Bad and Not-So-Bad Arguments for Shareholder Primacy,” Southern California Law Review 75 (2002): 1189–1209.Google Scholar

68. Meese, “The Team Production Theory of Corporate Law,” 1634. Stout recognizes that the choice among the competing agent-principal and team production models depends, at least in part, on the empirical evidence, and she offers some evidence with regard to charter provisions of initial public offerings and discusses the problems of obtaining empirical evidence. Stout, Lynn A., “The Shareholder as Ulysses: Some Empirical Evidence on Why Investors in Public Corporations Tolerate Board Governance,” University of Pennsylvania Law Review 152 (2003): 667–712.CrossRefGoogle Scholar

69. Alchian and Demsetz, “Production, Information Costs, and Economic Organization,” 782.

70. Meese, “The Team Production Theory of Corporate Law,” 1669.

71. Hansmann, Henry and Kraakman, Reinier, “The End of History for Corporate Law,” Georgetown Law Journal 89 (2000–2001): 448.Google Scholar

72. Blair and Stout, “A Team Production Theory of Corporate Law,” 282.

73. Ibid., 283.

74. Millon, “New Game Plan or Business as Usual?” 1031.

75. Ibid., 1038.

76. Ibid.

77. Charney, David, “Workers and Corporate Governance: The Role of Political Culture,” 117;Google Scholar and Rock, Edward B. and Wachter, Michael L., “Tailored Claims and Governance: The Fit between Employees and Shareholder,”127; both in Employees and Corporate Governance, ed. Blair, Margaret M. and Roe, Mark (Washington, D.C.: Brookings Institution Press, 1999).Google Scholar

78. Blair and Stout argue at length that the use of legal and market incentives to prevent opportunistic behavior is inadequate and that internalized norms of trust and trustworthiness play an important role in facilitating cooperation in business firms. Blair and Stout, “Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law.”

79. Lee, “Efficiency and Ethics in the Debate about Shareholder Primacy,” 549–50.

80. Ibid., 545.

81. Blair and Stout, “A Team Production Theory of Corporate Law,” 251.

82. Lee, “Efficiency and Ethics in the Debate about Shareholder Primacy,” 546.

83. Stout, “The Shareholder as Ulysses,” 688.

84. Ibid., 689.

85. Ibid., 671.

86. Kostant, “Team Production and the Progressive Corporate Law Agenda,” 675.

87. Ibid., 669. For discussions of how corporate laws develops norms of behavior, see Eisenberg, Melvin A., “Corporate Law and Social Norms,” Columbia Law Review 99 (1999): 1253–92;CrossRefGoogle Scholar and Rock, Edward B., “Saints and Sinners: How Does Delaware Corporate Law Work?” UCLA Law Review 44 (1997): 1009–1107.Google Scholar

88. Blair and Stout, “Trust, Trustworthiness, and the Behavioral Foundations of Corporate Law”; and Mitchell, Lawrence E., “Trust and Team Production in Post-Capitalist Society,” Journal of Corporation Law 24 (1998–1999): 870–912.Google Scholar

89. For a discussion of the possible implications of the team production model for the law of fiduciary duties, see Gregory, Scott Crespi, “Redefining Fiduciary Duties of Corporate Directors in Accordance with the Team Production Model of Corporate Governance,” Creighton Law Review 36 (2002–2003): 623–42.Google Scholar Kaufman and Englander draw some implications of the team production model for the composition of boards within existing corporate governance. See Kaufman and Englander, “A Team Production Model of Corporate Governance.”

90. A critical assessment of the power of corporate governance to affect distributive justice is offered in Maitland, Ian, “Distributive Justice in Firms: Do the Rules of Corporate Governance Matter?” Business Ethics Quarterly 11 (2001): 129–43.CrossRefGoogle Scholar For responses to this article, see Beck, John H., “Distributive Justice and the Rules of the Corporation: Partial versus General Equilibrium Analysis,” Business Ethics Quarterly 15 (2005): 355–62;CrossRefGoogle Scholar and Witztum, Amos, “Corporate Rules, Distributive Justice, and Efficiency,” Business Ethics Quarterly 18 (2008): 85–116.CrossRefGoogle Scholar

91. Millon, “New Game Plan or Business as Usual?” and Meese, “The Team Production Theory of Corporate Law.”