Active agents, passive principals; the
role of the chief executive in corporate strategy formulation and
James Dow, Clara Raposo
In this paper we use agency theory to study the active
role of the chief executive in the formulation of corporate strategy.
Unlike traditional applications of agency theory, we allow the agent (CEO)
to play a role in defining the parameters of the agency problem. We argue
that CEOs will have an incentive to propose difficult, ambitious
strategies for their corporations. The effect arises because in
equilibrium, the agent may be overcompensated in the sense that the
participation constraint is not binding in determining his compensation.
The agent can exploit this by proposing ambitious corporate strategies,
thereby influencing the parameters of the constraints in the agency
problem. The principal (the owners of the company) can mitigate this by
precommitting to pay high compensation regardless of the manager's chosen
strategy, but may optimally prefer not to do so.
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