Principal–agent approach to energy executive compensation design

Abstract

The principal–agent problem attracted attention from researchers 20 years ago in connection with Enron. The paper reports on the behavioral experiment of designing energy executive compensation contracts. An experimental approach based on principal–agent theory was applied (1) to design a fixed and variable component of the compensation contract, (2) to assess the impact of information disclosure on the terms of the contract, (3) and to estimate the response of the manager’s efforts to the terms of the contract. Hypotheses testing showed that (a) disclosure does not affect the decision-making of the owners (principals) regarding the size of the energy executive compensation package to the management (agents), (b) the nature of the disclosure has no significant impact on the manager’s acceptance (or rejection) of the compensation package, (c) an increase of the energy executive compensation package has an impact on the increase of the manager efforts, (d) disclosure does not significantly affect decision-making of managers regarding the level of their efforts.

Keywords

• Behavioral experiment
• Energy company governance
• Principal–agent problem