Pay without Performance: Review

Bebchuk and Fried present a tight, persuasive argument demonstrating how managers utilize their power to extract rents and decouple pay from performance.  The structure of the book strengthens their message as it cover a broad range of topics yet transitions smoothly from point to point.  They begin by highlighting what arm’s length bargaining is supposed to portray, then describe what actual bargaining resembles, and demonstrate how their theory actually fits reality. The heart of the book documents how pay is decoupled from performance on account of managerial power. They finish by tying everything together through recommendations for ways to move forward.

Pay without Performance is an excellent resource for anyone who wants to learn more about executive compensation and/or corporate governance relationships between executives, boards, and shareholders.  The authors utilize minimal jargon and provide examples of concepts that might be hard to understand for readers with little financial background. The book might be out of range for the non-financial reader but if supplemented with other sources, the message is digestible.  A beginner and certainly an intermediate finance student would benefit from the amount of detail presented. Although the book lacks visuals and author calculated statistics, the authors have completed a thorough literature review, compiling study after study to support their claims.  It is the wealth of empirical research that makes the book so persuasive. 

This book has the potential to appeal to heterodox and orthodox schools, as Bebchuk and Fried draw from both perspectives.  On the orthodox side, the authors give incentives the primary role in executive and board decisions.  At times, they employ the concept of utility to discuss why one pay package might trump another. Throughout the book, they heavily rely on the concept of efficiency to explain company actions. 

The discussion of power is not something usually found in orthodox financial economics.  Bebchuk and Fried not only acknowledge executives hold power, but also actively use it to extract rents and insulate themselves against their own poor performance.  Once garnered by managers, power can be used to accumulate more power and thus further protect themselves from changes or reforms not in their best interest.  Psychological effects have a substantial role to play in the relationship between directors and CEOs.  The authors pull from behavioral finance by offering social and psychological reasons for the board’s loyalty to the executives and not shareholders. 

Bebchuk and Fried approach executive compensation holistically and extensively.  By not exclusively invoking orthodox or heterodox perspectives, they paint a robust picture of executive compensation.  Incentives and efficiency are just as important as power and psychology.

That said, they inspect and challenge executive compensation only in the interest of fair process.  The authors separate their argument from the moral argument at the very beginning and openly consent to higher CEO pay as long as the bargaining carried out follows the arm’s length model.  By separating themselves from moral concerns, their argument gains objectivity at the cost of leaving other stakeholders like regular employees and the community out of the picture.

The authors repeat the scope of their book and challenging the level CEO pay or the distribution of earnings is not within it. They do no discuss how CEO compensation for good performance is untangled from the rest of the employee’s contributions. Nor is there a conversation about how communities are better off when CEOs engage in arm’s length bargaining.  Although narrowing the scope of their book has allowed Bebchuk and Fried to completely and robustly dissect executive compensation on a micro-level, it has in effect excluded how executive compensation fits into the big picture.  What they call for is fair process and once it is obtained, in their eyes, the battle is over.

Future research could widen the authors’ message to include more of a general dialogue about CEO pay and statistics. Further research could also connect this literature to the growing radical literature on maximizing shareholder value – how stock buybacks are increasing shareholder wealth and how that impacts executive compensation. 

This book is a thorough introduction to executive compensation involving analytical tools from both heterodox and orthodox schools.  The authors utilize a fascinating array of studies to demonstrate how executives use their power to extract rents and receive pay that does not relate to their performance.  Even though the scope of the book does not provide space to challenge the level of CEO pay, question how much company success is because of CEO decisions, or how executive compensation affects social welfare, it is a conservative place to start in critiquing executive compensation and well worth a read.