Compensation Representatives: A Prudent Solution to Excessive CEO Pay


Currently, CEO pay is determined by a company’s board of directors, subject to limited shareholder approval in certain circumstances. However, as Lucian Bebchuk and Jesse Fried have demonstrated, boards of directors and CEOs do not necessarily engage in real arms length bargaining over CEO pay. Instead, CEOs may exert managerial power to extract economic rents above and beyond what they could have obtained in an arms length negotiation. To address the problem, Bebchuk and Fried have proposed that large shareholders be allowed to nominate candidates for the board, and that companies be required to pay the expenses for any proxy fight if the shareholder’s nominee receives a designated minimum level of support.

Some commentators have taken issue with their conclusion that CEOs are in fact overpaid, and others have objected to their proposed remedies. This article accepts the fundamental point that the CEO pay-setting process is flawed and that reforms are necessary. Nonetheless, it recognises that high CEO pay may be attributable to numerous factors other than managerial power, and it questions whether certain of Bebchuk and Fried’s proposed solutions might have unintended negative consequences for matters beyond CEO pay.

Therefore, to remedy the problems in the pay-setting process, this article proposes that large shareholders be allowed to appoint non-executive “compensation representatives” to look after the interests of all shareholders on matters relating exclusively to CEO pay. Compensation representatives would have the right to attend all compensation-related meetings, to question board members, to make recommendations, and to report their views to shareholders. Shareholders in turn could use the representative’s report as a basis for rejecting unreasonable pay arrangements.

This proposal would insert into the pay-setting process parties who are immune to CEO pressure and responsive to shareholder concerns. It would address compensation without fundamentally altering the relationship between the shareholders and the board. Its implementation is highly feasible, since it could be adopted by shareholder by-law, without changing existing law. Finally, it could be vindicated or discredited by the market itself. As such, it would constitute a prudent solution to excessive CEO pay.


Banking and Finance Law | Business Organizations Law | Law and Economics | Securities Law

Date of this Version

August 2006