The last decade has seen an immense amount of turmoil in the financial world. Especially the incentives and compensation packs of CEOs have been scrutinized and criticized. This essay sets out to explore possibilities of redesigning compensation pay that will increase efficiency and reduce imprudent risk taking. To justify and lay a theoretical foundation the essay will first discuss certain academics. Firstly the principal agent problem will be discussed then the distinction between the level and structure of pay will be examined. Thereafter a review and critique of the common compensation schemes before the main differences between the banking and manufacturing sector are outlined. The essay will conclude with a suggestion on how to improve the current proposals of compensation pay. .
The Principal-Agent Issue.
The principal agent theory outlines the issue of making both parties acting on behalf of each other's best interest, detriment the agents own. The issue arises as the agent makes decisions that affect the principals. The principal party here represents shareholders and the agent the CEO, the shareholders are the owners and the CEO is the one in control. Naturally the two parties have a conflict of interest when it comes to their main objective. The shareholders goal is to maximize profit through their shares and dividend pay whereas the CEOs focus will be on their own interest and how to fulfill these. Further is it fundamental to stress how there is asymmetric information between the two parties. It would be nearly impossible for shareholders to oversee all the actions made by the CEO. As a CEO normally is selected based on mix of high academic knowledge and business skills it is not usual for the average shareholder to comprehend the CEOs action and thus decide if it actually is in their best interest or not. It would not prove feasible in terms of cost or time either. The common purposed solution such as in many other sectors is granting the CEO a fixed pay.