their effects on managerial risk taking and time horizons (Wiseman & Bromiley, 1996).
The only viable strategic alternative at this stage may be to take a public company private. Restructuring of a declining organization following a public-to-private buyout may result in a reinvigoration of the life cycle as more transparent incentive and governance mechanisms are introduced in the form of increased managerial equity, monitoring by private equity firms, and a commitment to service debt. As such, the organization may narrow the scope of its activities and start a new cycle.
In sum, an effective incentive mechanism depends on patterned variations over the OLC, rather than conforming to a universalistic model. Organizational context underlines the ―open‖ nature of organizational interdependence, such that,whereas mature firms may be concerned with reducing agency costs through incentive alignment, new entrepreneurial firms face different challenges in terms of making sure that founder-managers are able to anticipate future technological developments and growth opportunities as they try to buffer environmental uncertainties (Filatotchev & Bishop, 2002).
The potential benefit of various governance practices is at the core of corporate governance research. However, Aguilera et al. (2008) argued that organizational context may also affect potential costs related to the inputs of corporate governance.
These often appear as ―externalities‖ or unintended consequences that stem from or man- ifest in the broader environment of the organization and reduce the effectiveness of corporate governance. Such costs will vary across firms to the extent that they operate in different sorts of environments.
Executive compensation schemes may have associated costs of several types, starting with the direct costs that are reflected in the firm’s balance sheet and other accounting documentation (Hall, 2003). In addition, incentive systems may impose less explicit opportunity costs (e.g., changes in managerial risk preferences) and reputational costs (e.g., costs of fraud, misconduct, or executive irresponsibility). These various costs may have different effects on the multiple parameters of incentive schemes’ effectiveness, implying potential trade-offs between them.
Previous research is mainly focused on direct costs of various types of executive compensation, such as the out-of-pocket expenses associated with executive stock options (Oyer & Schaefer, 2006; Ronen, 2008). The cost of executive stock options
to shareholders can be estimated using the familiar Black-Scholes formula, though this may not be applicable to executive options that cannot be traded continuously thanks to vesting and holding periods (Hall & Murphy, 2002). Notably, these costs differ according to different sectoral and national regulatory environments. An important implication is the differential impact of costs on firms depending on their resource capacities. For example, large firms with sufficient resources can more easily buffer these direct costs, while smaller firms with greater resource constraints may be unable to comply and may consequently face relatively high costs of executive bonding and incentive alignment (Aguilera et al., 2008).
Beyond these direct costs, executive compensation also entails less explicit and more indirect opportunity costs, which are often difficult to quantify (Hall, 2003). These costs relate to how an incentive mechanism affects managers’ risk perceptions and strategic priorities and consequently the exploitation of business opportunities, and they may differ depending on the organizational context. For example, Hall and Murphy (2000) argued that, because executives in mature companies are forced by vesting requirements and insider share restrictions to hold more
company equity than is desirable from a portfolio diversification perspective, they discount the value of their equity holdings. This ―value-cost wedge‖ is the price that companies have to pay in order to generate the benefits of equity-based pay.
At the other end of the OLC spectrum, Allcock and Filatotchev (2009) examined the effects of opportunity costs associated with executive stock options in IPO firms. These authors integrated behavioral agency research (e.g., Wiseman & Bromiley, 1996; Wiseman & Gomes-Mejia, 1998) with ―prospect theory‖ research (Kahneman
& Tversky, 1979) and suggested that executives’ risk preferences and decisions may be driven by ―problem framing,‖ with their retained equity stakes after an IPO being an important factor affecting this framing. The lock-up restrictions on equity trading after the IPO may create transaction costs that prevent executives from adjusting their equity holdings to an optimal level. Therefore, using locked-up executive equity as a reference point for framing problems as gain or loss, the authors’ behavioral model predicts that executives should exhibit risk-averse preferences when considering the appropriateness of different typesof incentive schemes at an IPO.
Finally, executive compensation schemes may influence costs related to the reputation of the firm. For example, Hall (2003) and Buck and Shahrim (2005) discussed problems of executive gaming or skimming associated with stock options. Equity-based pay, combined with the intense pressure to meet investors’ expectations, can create unwanted consequences such as accounting manipulation or falsification of information aimed at boosting the stock price. As Hall (2003, p. 25) put it, ―High-powered equity-based pay—particularly when combined with very short or no vesting restrictions—can encourage actions that are unethical and wasteful at best, and massively valuedestroying and fraudulent at worst.‖ Some companies may be more vulnerable to reputation costs, such as auditing firms or banks, than firms that are traditionally less reliant on reputational capital, such as manufacturing firms. The important point is that the degree of direct, opportunity, or reputational costs associated with a particular compen- sation practice will affect different aspects of effectiveness, and their salience will vary across different organizational environments.
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