Economic and psychological perspectives on CEO compensation: a review and synthesis

To many, the principal–agent model is the obvious lens through which executive pay should be viewed. Such a sentiment sits uncomfortably with a large number of empirical studies suggesting that the process of determining executive pay seems to be more readily explained by recourse to arguments of managerial power and influence. This article investigates the micro-underpinnings of boardroom behavior in order to explain this departure from principal–agency theory’s argument that executive compensation serves to align interests between the owners of the company and its senior managers. We find that there are strong interaction effects among social influence variables and the social setting of boardroom activity. Generous pay awards, bearing only a weak connection to corporate performance, are explained in the context of the social psychology of the boardroom. These results and a review of the empirical research, suggest the need for a more comprehensive model of executive compensation that incorporates both economic and psychological determinants.