Executive Compensation, Shareholder Activism, and Long-Term Firm Performance: A Critical Reassessment of Agency Theory in Modern Corporate Governance

Abstract

This article evaluates the agency theory. The agency theory has reigned in the corporate governance discourse in almost 50 years, which assumes that executive compensation must be designed to align the interests of managers, who should maximize shareholder wealth, and other monitoring systems such as shareholder activism. This paper has critically evaluated these assumptions based on current empirical evidence and current governance practices in a critical manner. Based on meta-analytic results, new activism data, and emerging compensation trends, we state that the agency theory framework needs to be revised based. As our discussion shows, three core issues can be identified: (1) the relationship between the pay and performance of the CEO is more subtle than the agency theory would suggest, and firm size is the strongest predictor of compensation levels; (2) shareholder activism is more frequently aimed at governance and ESG matters than the pure financial underperformance, and its effects on the long-term value creation are uncertain; and (3) both compensation systems and activist We suggest a broader theoretical framework that takes stakeholder views into consideration, behavioural knowledge, and time. The paper has ended by finding ways through which governance can be reformed to make the executive compensation more in line with the long-term success of the firm.

Keywords: Agency theory, executive compensation, shareholder activism, corporate governance, CEO pay-performance, ESG, stakeholder theory, sustainable value creation, behavioral governance, meta-analysis