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AGENCY THEORY AND ITS IMPLICATIONS FOR CORPORATE GOVERNANCE
AND EXECUTIVE COMPENSATION
I. Overview of agency theory
1.1. Principal-agent relationship and agency problems
The concept of principal-agent relationship and the problem arising from it, commonly known as
the agency problem, are some of the crucial challenges, that exist in the area of corporate
governance due to the fact that the ownership and control of a firm are separated. Within this
setting, shareholders who act on the behalf of management, principals, delegate decision making
powers to executives, agents, who may have different interests from that of generating the
highest return for shareholders (Becht, Bolton & Röell, 2003, p. 197). This divergence of
interests leads to agency problems whereby the agents may act in their self-interest as opposed to
the best interest of the principals and this makes them to take decisions which are contrary to the
best interest of the shareholders (Bebchuk & Fried, 2003). Agency costs are thus present in
various forms, perhaps most even dominantly in a way that exposes executives‟ self-serving
propensity to improve their corporate power and paychecks at the expense of shareholder value
(Agrawal & Knoeber, 2021). For instance, managers may get into empire building whereby they
offer the spikes their expansion strategies or mergers and acquisitions that could even enhance
their succeeding potentials for recompense but are worthless to the firm worth from the
shareholders‟ points of view. Such misalignment may erode shareholder wealth or negatively
impact the structurally firm. This is why it is necessary to employ practicable measures that
eliminate agency costs and ensure a closer correlation between a manager‟s and shareholder‟s
objectives. These include stock options and other bonuses that are related with organizational
performance indicators; these tools can influence executives to make decisions that will be good
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for the shareholder (Bebchuk & Fried, 2003). The active vetting role of a board of directors as a
watchdog is also essential for improving the organizational oversight. It should oversee
management actions and the strategic plans in a way that they can best represent the
shareholder‟s wishes while being guarantors of the executive pay and performance transparency
(Becht, Bolton, & Röell, 2003). In addition, enhancing corporate culture awareness with focus
on ethical considerations and sustainable value added, can serve as measures that address the
agency problems. Better practices include regular audits, transparent reporting, and engaging
stakeholders might strengthen the relation between managers and shareholders any further.
1.2. Agency costs and monitoring mechanisms
Agency costs and monitoring mechanisms should be effectively implemented in an effort to
address the problem of separation of ownership from management within the context of
corporate governance. Agency costs refer to the costs of monitoring the behaviour of the agents,
as well as the costs of controlling the agent‟s actions when these are contrary to the interest of
the principals (Becht, Bolton, and Röell, 2003). These costs pose a serious threat to the
performance and satisfaction level because they affect value of operations of the firm. To
address these agency costs it is imperative that monitoring mechanisms are put in place to ensure
there is accountability. The first is a structural reform that enables independent directors on the
board of directors. While they are not part of the company‟s executive management team,
independent directors can bring impartiality to the forum and are usually expected to act in the
best interest of shareholders (Agrawal & Knoeber, 2021). Their presence also guarantees that all
managerial actions are being (re)searched and driven to enhance shareholder value, which in turn
helps to minimize the occurrence of self-interested activities constituted by executives. The other
forms of external control include shareholder proposals, and activism whereby investors are able
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to exercise a lot of leverage in the management of companies. The following is an understanding
of how the institutional shareholders can bring reform in the company policies and practices :
The influence of institutional investors can be determined by examining the specific actions they
recommend or demand from the company (Bauer, Moers, & Viehs, 2015). Empirical evidence
that activist shareholders can pressure the managers into enacting more shareholder friendly
moves, leading to more effective alignment between the shareholders‟ interest and
management‟s activities. Also, another idea that could significantly minimize the notion of
agency costs is the linking of the pay levels of the executives with the firm‟s performance
indicators. To achieve sustainable shareholder value, the compensation system must be linked to
performance with twenty years horizon rather than shorter targets such as an increase in stock
price, operating income, or return on equity (Heracleous & Papadimitriou, 2022). Evaluating pay
packages guarantee that executives are involved in the company‟s success in a more intimate
way than shareholders since they would be motivated to perform towards deeper standards.
1.3. Implications for corporate governance and executive compensation
In defining its remuneration packages, most executives factor in a base salary and other
provisions that are intended to ensure that executives and shareholders of the company have the
same objectives in mind (Bebchuk & Fried, 2003). However, If not handled properly, the
compensation policies may lead to increased agency costs since the executives are bound to
maximize agency rents for their own benefits in the shortest time possible or undertake more
risks than are desirable for shareholder value creation (Armstrong et al. , 2021). The following
are means of addressing these risks: Corporate governance frameworks are important when it
comes to risk management within an enterprise. Therefore the proper execution, and clear and
understandable link between effort and reward it can be seen that clear and unequivocal
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requirements of executive remuneration can better serve shareholders‟ interest by effectively
aligning managerial activities. For instance, indexing large parts of the executives‟ remuneration
with long-term performance indicators like stock price increase, return on equity, and earnings
per share will compel the executives to implement sustainable improvement strategies that are
profitable for the firm in the long run (Berrone & Gomez-Mejia, 2009). Such frames also usually
require extensive and demanding procedures of monitoring by independent board of directors
responsible for determination of executive remuneration. Also, the adoption of the international
corporate governance practices and regulations as a benchmark for domestic standards proves
that executive compensation and governance are related correlated aspects, and thus call for an
integrated and multi. faceted strategy. Despite the fact that global cultures more and more
converge, it may be still different in various countries what norms and regulations demand from
companies, and it influences how they create their governance systems and their compensation
policies. According to Albuquerque et al. , 2022, referring to these examples means that it is
possible to learn from experience and, therefore, enhance your company‟s standards to vie for
success on the international market. The like above aspects help firms to work on the corporate
governance system, decrease agency costs, and increase the overall performance of the
organisation. With regard to the manager-Shareholder debate, good corporate governance not
only helps to converge managerial and shareholders‟ objectives but also enhances accountability
and corporate transparency as critical tools to improving organizational decision-making and
stakeholders‟ confidence.
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II. Fiduciary duties and corporate governance
1.1. Board of directors' responsibilities and accountability
The functions of the board of directors are diverse and can be shortly described as defining the
corporation‟s vision, regulating its management, and reporting to the shareholders (Cheng,
2014). Boyd (1994) defined that, effectiveness boards‟ main functions are to monitor the
management‟s actions for independence, avoid inner conflicts of interest situations, and protect
shareholder‟s interests form management‟s undue risk-taking or self-interested behaviors. For
example, the audit committee is expected to monitor financial reporting and disclosure and
controls on financial reporting and financial statements for accuracy, and make certain that they
meet all the regulatory standards and requirements (Davidson, Xie, & Xu, 2004). This one is
involved in liaising with the internal and external auditors in the reporting of any financial risks
to improve on the level of compliance in an organization. The governance committee is a vital
aspect of corporations as it determines policies that should be implemented, controls the
composition of the board, and evaluates practices for conformity to better governance principles
(Leblanc & Gillies, 2005). This includes selecting and recommending people for board roles,
appraising the board on its performance often, and making sure the structure of the board and
hoe it works for the value of the company are sufficient. Amazingly, using performance
evaluations and other formal reporting systems, it is very possible to address the issue of
accountability to the shareholders and other stakeholders (Daily et al. , 2003). In so doing,
boards can guarantee that appropriate measures of organizational responsibility and ethical
performance are followed throughout the company, and that decisions made at the executive
level are consistent with shareholder values. Interestingly, establishing long-term investor
relations through timely and effective communication is also vital for maintaining investor
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interest in and commitment to those strategies and performance reports (Healy & Palepu,
2001). Performing their responsibilities properly, boards can improve the level of corporate
governance and minimize agency risks, which will contribute to the sustainable increase in
corporate value. By either ensuring that the Management constantly has the best practices,
strategies, or policies, this all-inclusive approach to governance guarantees the company, not
only does it withstand all negative publicity, but it also conforms to the best standards when
competing in the current Mercantile business.
1.2. Executive compensation and incentive alignment
There is a common thread in corporate governance, whereby executive remuneration is a system
in place that seeks to enforce the synchronization of the CEO and other employees‟ objectives
with the shareholders. Remunerations could be in form of cash, incentives, earnnings, bonuses,
rewards such as stocks or stocks options and any other forms geared towards ensuring that
executives deliver the set targets (Boyd, 1994). These packages are designed in a way that they
should urge managers to act in a way which would further improve the worth of the firm.
Nevertheless, the fact that these packages are constructed may create misalignment issues, where
the executives are motivated to short-term performance pursuits, rather than long-term value
creation (Byun, 2022). For example, managers may make unsound decisions such as cutting
costs to the bare minimum or employing other measures to make their company look good in the
short-term, from the quarterly perspective, but actually are damaging the longer-term health of
the firm. When it comes to establishing benchmark for executives, peer group comparisons
contaminates increase executive pay without corresponding changes in performance and hence
can lead to skewed compensation contracts (Bizjak, Lemmon, & Naveen, 2008). This
benchmarking approach can produce a ratchet effect in which each company attempted to
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provide at the least as good or better pay packages of other companies, which can result to
increase in general executive pay despite undesired individual or company results. This may
result in a situation where actual and deserved compensation greatly diverge from nominal
values, thus failing to match the value being created for shareholders. To manage with such
risks, boards should structure remuneration policies that should incorporate long term
performance indicators in a way that the executives will be get rewarded for better performance
and not short term gains. This can be done through vehicles like restricted stock units (RSUs)
and performance shares, which are granted and ultimately convertible over time-often with a
long time horizon-hinged on the attainment of certain corporate objectives. Furthermore, details
like clawback provisions enable specific corporate officers to recover bonuses and other rewards
they previously received in cases where necessary restatements or legal violations have occurred
and ensures that executives are held responsible for their decisions (Boivie et al. , 2016). These
provisions work as a barrier to restrict any wrong or immoral actions from the director and to
encourage them to make the right and appropriate decisions regarding the welfare of the firm and
its shareholders.
1.3. Shareholder rights and stakeholder considerations
Shareholder rights and stakeholders issues are the core aspect of corporate governance
frameworks to achieve a proper working of the structure and condition of companies dealing
with investors‟ rights for different stakeholders. Majority of the shareholders‟ powers are worked
out in such processes as voting for important issues like the policies of managers‟ remuneration,
mergers and elections of directors (Cai & Walkling, 2011). This leads to shareholders‟
participation in most of the major corporate decisions and thus be in a position to have their
voices heard in the corporate governance system. Speakers have claimed that say on pay votes
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allow shareholders to exercise direct control over pay policies, thereby increasing the level of
accountability and credibility (Cai & Walkling, 2011). Through the advisory vote, shareholders
are able to voice their endorsement or otherwise of the remuneration proposals in their company,
and hence organizations are in a better position to offer their directors‟ remuneration schemes
that accommodate shareholders‟ opinion. When the management incorporates the stakeholder
view in its strategic decisions, it amounts to valuing and adapting sustainable and ethical
business solutions that present a greater long-term value for the company and society. For
instance, any firm operating within an environment also considers policies that are
environmental friendly not only as a way of conforming to policy laws, but also to cater for the
increasing customer demands in environmentally friendly goods and services in the market.
Moreover, its ethical business policy that promotes equality and fairness for all the stakeholders
can help to avoid such undesirable outcomes as the loss of reputation and legal prosecutions; As
a result, it will safe the company forthe long-term perspective (Chen & Zhu, 2021). Delimiting
the rights of shareholders and configuring the importance of stakeholders is a challenging issue
in governance. This not only requires fulfilling the legal duties of being an economic entity
directed at the creation of shareholders‟ value, but also the obligation of being a responsible
member of the economy realm and bringing some sort of value add in the economic and social
system. Therefore, through integrating global corporate governance practices with shareholders
as well as stakeholders, businesses can work towards enduring success, establish favorable
image, and cultivate sturdy business models that would help them to withstand in the existing
global structure (Cheng, 2014).
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III. Executive compensation practices
1.1Components of executive compensation packages
Elements of executive remuneration increase goals contain among several factors aimed at
attracting, maintaining and motivating qualified employees. They tend to consist of fixed and
guaranteed compensation that may contain base salary, short-term incentives, variable pay such
as bonuses and stock options, company- granted stocks called restricted stock units (RSUs), and
other long-term incentives (Core, Guay, & Larcker, 2003). Fixed pay is the initial and primary
determinant of pay structure as it establishes a base level pay that offers executives stable wages;
variable pay on the other hand comprises of bonuses and other incentives that are earned when
specific short term targets are met (Cuñat, Giné, & Guadalupe, 2021). These short-term incentive
bring about short-term outlook through the achievement of tangible organizational goals towards
the success of the organization. Stock options and RSUs are useful for managing executives‟
incentives to lead the company because they are dependant on the organisation‟s results and
share price growth (Core, Guay & Larcker, 2003). This is achieved through the vesting of a part
of remuneration based on the company‟s performance, this ensures that the executives work
towards achieving the shareholders‟ goals of value creation. Other incentives are valued add-ons,
which can be in form of retirement benefits, health insurance of employees and perquisites
among others which when incorporated in the compensation package make it even more
appealing (Daily, Dalton, & Rajagopalan, 2003). These six have the ability of enhancing the
financial position of executives, as well as boost their well-being and overall satisfaction, thereby
improving their commitment towards the organization. Bundling some of these components,
companies wish to come up with autre competitive compensation structures that would compel
the executives to perform beyond expectations and have their goals resemble that of the
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business‟ shareholders. Importantly, it is also significant to emphasize that executives are
motivated to act in a way that aligns with the firm‟s strategic aims and serve the company‟s
financial performance, which in its turn positively influences shareholders and other
stakeholders. These compensation structures assist in enhancing recruitment and maintaining
organizational employee talent particularly for leadership positions, given the increasing
competitive nature of the environment at the present time in which organizations require
effective leaders who can effectively manage change and opportunities.
1.2. Performance-based incentives and equity awards.
These two methods of executive pay have been advocated widely as tools that can be effective in
changing the behavior of the executive and linking executive pay to the organization‟s
performance as well as the shareholders‟ value. These include annual incentives which are in
form of bonuses, or the long term incentives tied to organizational goals such as increase in
revenues, earnings per share or return on investments as suggested by Devers et al. (2007). These
incentives directly relate the executive pay structure to the firms strategic plan and goals to
ensure that the executive fulfills the set goals instrumental to sustainable corporation
performance (Dalton et al. , 2007). With the aim of satisfying the expectations of shareholders
and consumers, companies incentivise performance through linking pay packages of executives
to value creation and shareholder wealth maximisation. Non-share forms of compensations
include; stock options or Restricted Stock Units (RSUs) which reinforces the connection between
the executive and the shareholder through an ownership interest in the earnings of the company
(Connelly et al. , 2021). These awards give the executive stock options so that the executive
benefits if he is instrumental in making the company successful. Since company executives are
shareholders, they are motivated to make strategic choices that will benefit the organization
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especially in a view of stock price and development. They make certain that communication and
any other actions taken are in the best interest of shareholders and contributing to the
maximization of the company‟s shareholders‟ value, its continuous growth, and profitability
(Datta et al. , 2009). Through this method of compensation, organizations ensure that executives
work on the interests of shareholders and the organization as a whole by being rewarded with
better pay if they make decisions that are beneficial for the company‟s shareholders and the
organization in the long run. The merit of performance-based incentives and equity awards is
that the levels of remuneration are tied to the achievement of stated objectives in an organization
and this emphasis on result-oriented strategies that yield the required company performance
goals. Further, these systems of compensating executives assist in the acquisition and
maintenance of the best executives due to the fact that performance will be encouraged and the
executives‟ benefits will be nearer to the interests of the shareholders. It is possible for
management teams in various organizations to leverage their talents and abilities in convening
different challenges and opportunities to provide the shareholders with long-term value.
1.3. Corporate governance and compensation challenges
Despite advancement in undertakings of corporate governance and compensation, there exists a
correlation between executive remuneration policies and patterns, shareholders‟ expectation and
regulation. Various studies have shown that issues to do with high CEO compensation cost,
perceived unfairness and opacity generate concern that results in shareholder activism or
recourse to the authorities (Devers, Wiseman, Buckey, & Baker, 2007). Owners, especially
shareholders in this case, also require closer monitoring and oversite of executive remuneration
because they are the ultimate „customers‟ of the top executives and their compensation needs to
reflect the share holder value. Also, there is another factor, which has been proven to receive
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considerable emphasis, and that is the balance between short-term and long-term incentives used
in structuring compensation packages that affect the conduct of executives (Cuñat et al. , 2021).
To some extent, short-term motivating factors tend to provide a short-sighted sense of
achievement and performance that is valued solely in terms of meeting stock market returns and
other short-term goals irrespective of these strategic horizons. Short-term rewards include cash
bonuses in the form of cash or other items while long-term incentives include equity incentives
like share options in order to encourage executives to embrace actions in the company‟s long-
term interest and mostly overall shareholder value. Mitigating mechanisms including
compensation committees and peer group benchmarking basically seek to address issues of
executive pay practices compared to the actual performance of a given firm and the benchmarks
in the relevant industries (Dalton et al. , 2007). It often focuses on assessing and endorsing
various strategies of remunerating executives basing on performance, market prudence, or the
financial condition of the firm. Nevertheless, there are still significant and enduring questions
for organisations, boards of directors, and compensation committees with regard to executive
pay, company performance, and shareholder value (Connelly et al. , 2021). Managing the growth
of the Organisation for the short-term fulfillment of financial targets, as well as the planning
aimed at the achievement of strategic targets, as well as the satisfaction of shareholders‟ and
regulators‟ demands is a challenging task that requires accurate management and
governance. Mitigating these challenges through well-framed design and clear portrayal of
responsivity and accountability, corporations should improve their governing model and make
certain that executive reward system is suitable for solid value creation and sustenance.
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IV. Agency conflicts and corporate scandals
1.1. Corporate failures and ethical lapses.
Scandals have become random in accounting where these scandals and ethical misconduct form
the major issues embodying corporate governance and risks affecting companies, its
shareholders, as well as other stakeholders. Such mishaps are realized through weak board
evaluation and scrutiny, inadequacy in risk policies, and misconduct from the directors and
CEOs (Diplock, 2021). Lack of board oversight is seen to lead to failure in monitoring new risks
that may be connected to the firm or failing to ensure that management is held to account.
Likewise, poor risk management policies may expose the companies to fraud and different forms
of illicit activity such as embezzlement, fraudulent financial reporting, and every other act of
breach of trust which has an adverse effect on the shareholders‟ confidence and reputation of the
company (Fama & Jensen, 1983). Disregard of the basic norms of ethical behaviors like bribery,
corruption, and conflict of interest also complicate the governance issues and erode the
credibility of the organization (Goshen & Hamdani, 2016). Managers being involved in unethical
activities in the organization contribute to imbondeiro to what their fiduciary duties entail thus
causing harm and loss of faith from stakeholders leading to harm of the company‟s image and
sustainability. These unethical actions may happen as a result of poor ethical direction to which
an organization is exposed, poor corporate culture or poor ethical standard-setting and
monitoring. To tackle corporate failures and ethical violations, there should be sound
governance systems, which involve independent board, clear reporting platforms, and proper
organizational culture emphasizing on ethical standards (Flammer & Bansal, 2017). Independent
directors bring impartiality and act as monitors and caretakers of the company to give
accountability to the managing directors and also shareholders and087 corporate reporting
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integrate financial reporting the objectives of which are meant to provide stakholders with timely
and accurate information regarding the company‟s performance and conducts. Enhancing
organizational culture that pursues accountability and consultancy to report possible instances of
ethical violation and neglect help to maintain ethical standards throughout the organization. The
future of business and organizations can be improved by encouraging accountability to minimize
the impacts of corporate failures and increase stakeholders‟ trust. Leadership, accountability and
risks management, in particular, integrity and corporate governance standards are crucial for
shareholder protection and organizational success in the long run.
1.2. Shareholder activism and governance reforms.
Combined with other corporate governance measures such as shareholder activism, shareholder
demand and the resolution to affect change is one of the best ways by which the corporates can
be made to be accountable to their shareholders. For instance, institutional investors along with
activist hedge funds, in combination with other shareholders, exercise powers within the
organization to call for changes in issues regarding the formation of boards of directors,
structures of compensations to executives and managerial strategies (Geletkanycz & Boyd,
2011). These activists may target firms with questionable governance structures or
underperforming managers with the objective of boosting shareholder value and improving the
fortunes of the company (edmans and gabaix, 2016). Measures aimed at enhancing shareholder
power and increasing board of directors‟ sensitivity to shareholders include proxy access,
majority voting, and other strenuous disclosure rules such as those that include shareholder
proposals (Faleye, Hoitash, & Hoitash, 2011). Proxy access as such is a procedure by which
shareholders are set with a chance to propose his/her person to the board to counter the directors
already in the board. Majority voting requires directors to be elected by a majority vote so that
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they can be hired to protect shareholder‟s interests in the same manner that they act under the
pressure from the shareholders. Increasing in disclosure and reporting of activities by the
corporations owing to laws such as Sarbanes Oxley and Dodge Frank‟s acts enhances the
awareness of the shareholders on the company‟s governance and financial performance
(Faulkender & Yang, 2013). However, activism is more of an investment channel where a
shareholder buys a firm‟s stock for the purpose of making changes and implementing new
policies in business especially g Tomegian mostly in the areas of governance. Another way by
which shareholders can influence the management of change in a specific direction is through
sending letters of proposal regarding corporate business, having battles for proxy and engaging
in a discussion with the management of the company you hold stock of. Hence, shareholder
activism still holds an authoritative solution of guaranteeing that shareholders meet their duties
by increasing company‟s shareholder value and encouraging proper corporate Governance
systems adoption.
1.3. Regulatory oversight and enforcement actions
With specific reference to the themes highlighted in this paper, it is imperative to note that
regulatory oversight and enforcement actions remain fundamental in the assessment of
governance compliance and penalties on organizations as well as sanctioning the latter for its
violations. The federal securities laws, as well as other self-regulatory organizations, are
enforced by regulatory bodies including the Securities and Exchange Commission (SEC) and the
Financial Industry Regulatory Authority (FINRA), corporate operations are also scrutinized and
allegations of unlawful conduct are investigated (Goshen & Hamdani, 2016). Such measures
may include monetary penalties, suspension and expulsion, and penalties for return of gains and
other measures that are corrective and preventive and that are intended to prevent repeat offenses
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and to safeguard investors (Diplock, 2021). Fining and prohibiting companies and individuals
with authorities of non-adherence to the set regulatory standards, the regulators make it clear that
no one is immune to penalties, thus encouraging companies and individual to obey governance
norms and ethics. The regulatory function serves to assess the severity of risks that may be
inherent in the financial structure, leading to having regulatory policies as well as The regulatory
finding plays the role of considering how risky the financial system is and whether action is
needed to deal with the risks thus having regulatory policies efficiently. Analyzing market
conditions, particularly, risks that can threaten stability in the financial markets or confidence in
securities, regulators can be ready to counter possible threats to markets and investors. However,
it is essential to note that the role of regulations is not without some difficulty such as availability
of resources, influence by financial regulatory agencies, and the vast nature of financial markets
(Flammer & Bansal, 2017). Lack of funds might prevent regulatory agencies from carrying out
comprehensive investigations and enforcement functions; regulatory capture pertains to the
nature of regulatory agencies‟ compromising due to influence from the industries they
regulate. Proper and strict regulation is still an indispensable element in today‟s economic
conditions, ensuring stability in the market, confidence of investors, and financial systems‟
reliability. Through enforcing and championing disclosure, accountability, and adherence to
good governance, the regulators thus have a critical responsibility of protecting the investor
interests and fostering the credibility and ethicality of the financial markets.
V. Executive compensation and firm performance
1.1. Pay-performance relationship and incentive effects.
The most iimportant thing is to to understand the pay-performance connection and incentive
impact for the purpose of shedding light on and analyzing the practices of executive
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remuneration as well as ascertaining the resulting implications for corporate actions and
performance. It also seeks to provide a signal of appropriate and desired executive behaviour
since the alignment between the executive pay and the firm‟s performance is viewed as a pivotal
mechanism to drive executives to act in the best interest of shareholders (Holmstrom, 2017).
Pay-performance sensitivity was in used to determine the relationship between changes in the
level of executive compensation and changes in firm performance hence capturing the executive
power of incentive alignment (Holtz-Eakin et al. , 1993). T shareholders, higher pay-
performance sensitivity is anticipated to lead to higher effort by managers as well as decisions
most suited for the company (Healy, 2022). However, there is a note of caution related to the
incentive alignment – All those implemented in compensation contracts such as the choice of
performance measures, the relative balance between short-term and long-term incentives and the
recent emergence of claw-back provisions. Compensation is an essential factor that needs to be
well managed by the company heads to ensure that executives are rewarded based on the
shareholder values to change their behavior and embrace performance management
strategies. To address the issue of linkage of pay with performance, better measures can
therefore include measures of performance in terms of earnings per share growth or return on
equity. Moreover, if the non-performance incentives are distinguished with the short-term
incentives and given larger weight, it will act as a signal to the executives that there is more
value being created in the longer run instead of incentives created through short-term rewards.
The clawback provisions, which state that the bonuses or other types of compensation paid to
executives should be recoverable in the event of restatement of financial statements or instance
of misconduct, are the other protective measures that have been put in place to address the other
harms that come with the exaggeration of risk-taking or engaging in unethical
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practices. Examining executive compensation and to harmonize it with shareholders to increase
companies‟ performance, make the companies more transparent, and to create sustainable value.
1.2. Executive compensation benchmarking and peer groups
Benchmarking is the process that helps compare the specific executive pay practices of the
company in question with the data obtained from the similar companies operating in similar
industry or market segment (Grieser & Hadlock, 2019). Specifically criteria used when selecting
a set of comparable firms include size, operation industry, and performance measure, so that the
comparisons made hold a lot of meaning as pointed out by Hermalin and Weisbach (1988). To
enhance employee motivation, reward systems have to be benchmarked to determine the level of
competition through adjustment that organizations can be able to make to attain the best
outcomes (Jensen & Meckling, 1976). One of the key benefits of benchmarking is that it
furnishes information regarding the current business trends hence making a compensation
strategy responsive to the current market environment on the other hand compares our
compensation practices with the best practices of other organizations. The emphasis on peer
group comparisons may as well cause what is termed as “peer group herding” whereby managers
replicate the compensation strategies of their counterparts without regard to their circumstances
(Goshen & Hamdani, 2016). This leads to herd behavior whereby compensation packages
offered are appropriate for the company‟s performance or strategic direction. However, peer
group benchmarking might lead to the increase in the executive remuneration, this wanting might
be felt due to the bidding competition that emerges within the similar set of executives
(Holmstrom, 2017). Consequently, the compensation levels may end up being set at higher levels
due to pressure from the executives and/or the workforce; this may give rise to issues such as
outrageous pay packages and lack of, mis-inking of the pay packages with that of the
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shareholders. It is crucial, in this respect, to have an equilibrium between the actual benefits that
benchmarking can offer and the costs and risks that dealing with comparisons entails when
approaching the design and the regulation of compensation. The researcher in this
study proposed that several factors such as performance and achievements relating to
compensation, market analysis, and organizational strategic maps should also come in to play
when managing the executive compensation packages. From this perspective, it is also important
that companies should use a lot of caution when engaging in such activities that may lead to
herding in the peer group and pay escalation to optimise pay practices by achieving the strategic
goals of the company and the overall corporate values.
1.3. Shareholder value implications and ethical considerations
When developing and implementing strategies for determining and providing executives‟
remunerations, social responsibility and potentially detrimental effects to shareholder value must
also be taken into consideration. There must be a clear understanding of how executive
compensation is being ordered to promote long-term shareholder value creation instead of
focusing on short-term financial and self-prerogatives (Healy, 2022). Ethical concepts include
justice, which relates to the notion of information and accountability when it comes to pay and
remuneration with a view of minimizing situations where companies over exaggerate their
remunerative packages (Jensen & Meckling, 1976). Elevated pay of Chief Executive Officers
and other top executives may lead to the development of perceived unfairness and hamper trust
with shareholders and other stakeholders, which may affect the organizational image and
financial outcomes (Holtz-Eakin, Joulfaian, & Rosen, 1993). However, compensation ethical
standards like backdating of stock options or manipulating the performance standards are likely
to attract legal and regulatory actions and yet reduce its reputation (Holmstrom, 2017). This
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means that there is a need for organisations to carefully consider the shareholder value analysis
and ethical concern related to excessive executive compensation. To respond to these issues,
specific ideas about the importance of fairness, transparency, and integrity at the level of
compensation governance practices should be implemented. This includes defining clear
guidelines to decide about the different parameters of executive remuneration, reporting the
different aspects of compensation policies and procedures, and making them more responsible
through increased levels of propriety and a more stringent system of checks and balances (Arya
& Mittal, 2022). There is need to have strong and proper ethical standards within the companies
and proper corporate governance practices throughout the organizations. In this article, you
already saw how stakeholders prefer companies that pay high executive remunerations but
concern themselves with the ethical aspects of such decisions, prioritizing their shareholders‟
value. In the corporate word, managers with decent pay and ethical behaviors are likely to seek
to achieve other tactics that benefit the shareholders, contributing to an effective organizational
culture, and organizational performance.
VI. Emerging trends and future directions
1.1. Shareholder empowerment and compensation transparency
For instance, the objectives of the majority control by the shareholders and disclosing of the
remunerations, which are paid to the executives, are the other two major well-known best
practices of corporate governance, which perform important roles for raising both the
responsibility and the co-ordination of the managerial incentives. When it comes to the
shareholder empowerment, one has to focus on such processes that can be characterized as the
processes through which shareholders per se influence the company‟s decisions, or can be
popularly characterized as the mechanisms of the shareholder control over the company, such as,
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for instance, the decision-making process regarding the choice of the executive remuneration.
Leverage structures that include say-on-pay votes permit shareholders to directly management
some of these aspects of corporate governance used to proactively drive and monitor the
enhancement of executive remuneration (Jiang, Stanford & Xie, 2014). Thus, other elements
like, explaining the structures of the executive remunerations with appropriate information on
particularly developed performance standards being annexed to the structures control the
executives remuneration by making decision over the compensation effectively (Jiraporn et al. ,
2018). In addition to shareholder confidence, transparency is able to offer the shareholders
more information on the executive pay practices and thereby minimizing information asymmetry
and enhancing the corporate governance (Lee, Lev & Yeo 2008). When a business wants to
communicate the roles to its shareholders or enhance the operating environment of the business
for clarity, it can strengthen the systems of accountability, enhance the stakeholder confidence in
the company and reduce the cost of the business in managing the relationship between the
principals and the agents where the remunerations of the executives are concerned (Lee, Lev, &
Yeo, 2008). Also high level of share holder accountability is enhanced with accountability in
overseeing of executive remuneration policies towards enhancing proper corporate governance
culture for better organisational value and sustain value proposition.
1.2. Regulatory changes and governance initiatives
Two dynamics that play as critical variables in company affairs are perhaps no other than
regulatory changes and governance that has been of major importance in determining executive
remunerations. Most of these changes result from legislations meant to increase governance,
politician and shareholder control and to dismantle corruption (Jiraporn et al. , 2018). For
example, the recent Act in the United States, Dodd-Frank, incorporated major demands such as
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the disclosure of the comparative pay between the chief executive officers and the workers as
well as the provision for shareholders to give their opinion over the remunerations through non-
binding votes (Jiang, Stanford, & Xie, 2014). Furthermore, in order to prevent bias, regulatory
bodies across the globe have advocated for independence of compensation committees
specifically in determining executive remuneration (Jiraporn, Kim, & Lee, 2018). At the same
time, a domain-based reforms by way of Industry associations, institutional investors as well as
proxy advisory firms augments the regulatory reforms by recommending for standard
requirements of executive compensation (Jiang, Stanford & Xie, 2014). Such measures may
include for instance: standards for performance-linked pay, contractual Prcovisions for
recoupment of awards, and a link between pay for executives and the value of shares for
shareholders in the long-term (Lee, Lev & Yeo, 2008). When organizational entities manage to
address the changes in the existing regulations or welcome the new concepts of governance, they
prove that they are concerned with promoting the best features of the corporate governance
systems and acting in the best interest of the stakeholders (Jiang, Stanford, & Xie, 2014).
Conformity to such demands create a chance for regulatory transparency to increase
organizational confidence among shareholders, employees, and the public (Liao, Luo, & Wu,
2016). Furthermore, concise proactive standing with governance initiatives displays endorsement
of ethical conduct and corporate responsibility (Lee, Lev, & Yeo, 2008). Compliance with the
requirements of the legislation governing the activity of the company and engaging in
governance activities and initiatives can be regarded as essential components of corporate
governance and as reflecting the company‟s preparedness and ability to respond to the various
challenges resulting from the need for sustainable value-creation.
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1.3. Stakeholder accountability and social responsibility
Adherence to the principle of accountability and social responsibility are distinctive principles of
corporations‟ governance that goes beyond the efficient of the stockholders‟ points of view but
include interested parties like the employees, the customers, society and community. Corporate
governance is defined as the acknowledgement of corporate obligations to society and obligation
to stick to ethics, the law, and regulations offered by the government (Jensen and Meckling S,
1976). This includes not only recognition of commitments but also partnerships and the dialogue
with stakeholders with the goal to identify their demands and potential issues, mutual
information sharing, and non-discrimination (Jiang, Stanford, & Xie, 2014). Social
responsibility goes beyond the realm of legal requirements and embraces the sphere of extra
activities undertaken to address critical Environmental, Social and Governance (ESG) issues for
global organizations (Jiraporn, Kim, & Lee, 2018). This ranges from corporate giving and social
responsibilities like environmental conservation and management, to policy and development
strategies that seek to enhance the wellbeing of an organization‟s immediate or wider community
(Lee et al. , 2008). Additionally, rising awareness among firms about the necessity of including
ESG aspects into the strategic management plans, as well as combining the financial and
sustainability targets goals (Jiang, Stanford, & Xie, 2014). Those organisations stakeholders
considering accountability and social responsibilities as significant are more likely to be trusted
and sustaining stakeholder relationships thus creating and sharing sustainable values to
stakeholders (Lee, Lev, & Yeo, 2008). In a bid to consult with the various stakeholders and
attend to their issues, firms are equally in a position to boost on the image, reduce on awful
aspects while embracing new development chances as stated by Jensen & Meckling (1976).
More to that, ESG information has to be incorporated into the frameworks of executive
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compensation to ensure good behaviour and set the self-interests of executives in parallel with
the common good goals (Jiraporn, Kim & Lee, 2018). Understanding stakeholders and their role
fosters accountability and social responsibility applicable to corporate governance hence
enhancing organizational resilience, reputation and success into the future. In doing so, the
business organisations satisfy the legal responsibilities of the stakeholders while demonstrating
responsibility towards the society and the earth, all in an effort of exhibiting corporate ethics and
garnering goodwill in their respective sectors.
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