An analysis of agency costs and executive compensation: The case of the life insurance industry

The study first analyzes theoretically how executive compensation could be affected by cross-sectional difference, if any, in the degree of managerial discretion among groups of companies. The degree of managerial discretion here captures the level of agency costs facing the principal. Theory predicts that incentive compensation relies less on performance measures as they are more easily affected by managerial discretion. Using the life insurance industry data, the study attempts to test the hypotheses that mutuals allow more discretion to their executives, and that companies with more officers on the board of directors have more difficulty in monitoring and controlling company operations. In general, the results from empirical analysis do not support the test hypotheses that executive compensation in the life insurance industry places cross-sectionally different weights on a performance measure potentially subject to managerial discretion, when companies are grouped by their ownership structure and the board of directors composition. We even found an evidence that may be interpreted as supporting a lower degree of managerial discretion for mutuals, contrary to the maintained hypothesis. In the first place, it is hard to imagine a group of companies allowing relatively more room for self-interested behavior to their management. The overall degree of managerial discretion may not be as different cross-sectionally as it appears, since it seems reasonable to believe that the rational owners, whoever they are, attempt to secure a comparable level of agency costs by making necessary adjustments. Even when there exists cross-sectional difference in the degree of managerial discretion, we may need to be more careful than simply grouping companies by their ownership structure or the board of directors composition. More comprehensive information may help improve empirical analysis. Also, our theory may be too restrictive to be related directly to empirical analysis, since it assumes that an only cross-sectional difference among companies is the degree of managerial discretion, which is not very likely to be true in reality. In any case, the study failed to confirm the common belief in the insurance literature that mutual executives are given more latitude regarding company operations