Theory

ENThe Regulation of Executive Compensation: An Agency Perspective

Guanghua Yu *

Abstract

According to the agency theory, directors or managers of corporations do not

bear all the consequences of their decisions as they do not own all the shares of a

corporation. From that perspective, it is necessary to establish various types of market

and contractual mechanisms to motivate or monitor the agents so that they will better

align their interests with those of the shareholders. Among the mechanisms, executive

compensation is a very important means to achieve this objective. The article

discusses the regulation of executive compensation by tax law and the law of

disclosure in the U.S. Judged by the efficiency criterion, discussion of the amount of

compensation is meaningless and any attempt to provide a legislative, administrative

or judicial standard is counterproductive. The emphasis of regulation should be

focused on how to strengthen the correlation between executive compensation and

corporate performance. Comparatively speaking, the disclosure regulation is more

conducive to a market economy and beneficial to the improvement of the capital

market. To implement in China an executive compensation system, which ties

executive compensation with corporate performance, the law must facilitate the

methods of financing such compensation ex ante while severely penalizing insider

trading, market manipulation, and exploitation of minority shareholders ex post.

I. Introduction

From an agency perspective, directors and managers who do not own all the

shares of the company they serve do not bear all the consequences of their decisions.

In order to better align the interest of shareholders and the interest of directors and

managers, agency theorists consider it necessary to establish market and contractual

mechanisms to motivate and discipline directors and managers. 1 Among the various

incentive and monitoring mechanisms, executive compensation is a...