A recent article published in Forbes refers the work by prof. Nikolaos Kavadis and his coauthor, prof. Xavier Castañer, of the negative consequences, in terms of firm diversification, of designing CEOs incentive schemes based on stock-like variable compensation in order to tackle classical agency problems. The research article by Kavadis and Castañer was published in the Strategic Management Journal.
[quotation extracted from Forbes Magazine] “In short, Castañer and Kavadis believe that agency theory actually encourages the diversification of companies into different fields that has often proved so ruinous for shareholder value. Based on an extensive study of French companies, many with international operations, they conclude that, in Castaner’s words, “neither the granting of stock options to the CEO, nor the CEO’s ownership of shares had a significant constraining effect on financial diversification.” Rather, the variable compensation associated with moving executives from strict salaries “actually leads to more financial diversification.” This is because the executive sees this unpredictability of compensation as risk – to which agency theory assumes executives are averse – and compensates by trying to make revenues less volatile and so increase the chances of hitting performance targets. At the same time, executives enhance their situation by creating organizations that are bigger and more complex and so require them to be paid more to run them”
Read the original research article here: http://onlinelibrary.wiley.