A Critical analysis of the role agency theory plays in executive remuneration

In view of recent scandals concerning executive remuneration and the current Australian government inquiry into its structure and regulation, this paper examines the foundation that agency theory provides for executive pay. The paper argues that agency theory assumptions concerning executive motivation and behaviour provide a flawed basis for the design of executive compensation. After examining evidence concerning the incentive effects of performance pay, and why incentive schemes may have adverse implications for firm performance, the paper considers the value of an alternative model, stewardship theory, for discussions about executive pay structures. The paper concludes that, given the limitations of agency theory as a conceptual basis for executive pay systems, a fundamental rethinking is required as to how executives are paid, and how corporate law regulates this aspect of governance.