Designing Management Compensation Systems - An Analysis Based on Preference Similarity and Behavioral Economics
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Abstract
The design of management compensation systems is an ever-present topic in corporate governance, with particular attention being accorded to designing compensation in such a way that managers and executives will act in the interests of the shareholders. The topic is not only subject to broad debate within the scientific community, indeed, it has also found itself under significant scrutiny in practice. Following company scan-dals such as that at Enron or, in general, the financial crisis of the previous decade, it is unsurprising that many have begun to harbor suspicions about the quality of current compensation systems and their viability. Together with a multitude of ambiguous em-pirical results, these scandals raise the question as to whether compensation systems should be designed based on agency-theoretical concepts only or whether they should be extended using additional perspectives such as elements stemming from behavioral economics.
The aim of this thesis was to provide recommendations for the design of management compensation systems by incorporating elements from behavioral economics to the discussion. First, recommendations based on the concept of preference similarity were made, and these were subsequently supplemented by recommendations derived from several concepts within the field of behavioral economics.
Based on the analysis of these concepts from behavioral economics it became evident that this field of research is not only capable of corroborating certain recommendations made by classical agency-theoretical concepts but that it can add multiple ones, too. In particular, it appears that a greater focus on human behavior and the differences be-tween humans in different cultures are important elements that should help in design-ing compensation systems that are better suited than those currently in place.