Agency costs of stakeholderism: Evidence from compensation contracting at AT&T

Agency costs of stakeholderism are the costs arising from the additional conflicts of interest that emerge when moving from shareholder primacy to stakeholder primacy. In the opening passage of the Spring 2024 edition of this journal, the editors articulated the advantage of focusing on sustainability, as opposed to the more widely used ESG. Noting a major concern, McCormack (2024, p. 2) explained that ESG represents “a wide variety of open-ended disputes that are often more social and political than economic in nature, and so subject to major confusion.” We agree and endeavor to reduce some of that confusion. In our paper, we recognize McCormack's concern and approach this important issue from an economic perspective (rather than a political or social perspective) by evoking agency theory, one of the most powerful instruments in the financial economist's toolkit. Agency theory involves the economic analysis of conflicts of interest. Another article from the 2024 Spring issue identified the important role of conflicts of interest in terms of understanding ESG. Specifically, in the Epilogue to his new book, Chew (2024, p. 28) notes that “conflicts between shareholders and stakeholders—and among different stakeholder groups themselves—are everywhere.” In another article from the Spring 2024 issue, Denis (2024) further contends that agency costs stemming from the paradigm shift from shareholder to stakeholder primacy may outweigh the benefits of stakeholder-centric endeavors (such as CSR). Therefore, from that Spring 2024 issue, we can conclude that conflicts of interest involving stakeholders are pervasive and potentially very large. In this paper, we seek to build upon these important insights. First, we formally define the agency costs of stakeholderism and then we identify specific examples of how these costs may arise and how these costs may affect firm value. Our paper considers the agency costs of stakeholderism in compensation contracts. Harkening back to the days of Friedman (1970) and Jensen and Meckling (1976), financial economists have long suggested that firms design management compensation contracts to minimize agency costs and maximize shareholder value. The seminal study by Jensen and Meckling (1976) provided an initial taxonomy of agency costs. Specifically, Jensen and Meckling (1976) identified agency costs of equity and agency costs of debt and presented examples of each. Applying this theory, previous studies of compensation structure, summarized by Yermack (1995) and Bryan, Hwang, and Lilien (2000), primarily focus on the agency costs of equity and emphasize the role of equity-based executive compensation in managing this conflict of interest by establishing a more direct link between manager and shareholder wealth. Further drawing upon this theory, John and John (1993) and Bryan, Nash, and Patel (2006) number among the empirical studies that explicitly consider how the agency costs of debt may also affect compensation structure. However, in addition to the agency costs of equity and the agency costs of debt, Denis (2024) suggests that there are agency costs that may fall into a different classification category (i.e., the agency costs of stakeholderism). We concur with Denis (2024) that there is more to the story. The most recent chapter of that story begins in August 2019 when the Business Roundtable (BRT) Restatement of the Purpose of a Corporation urged managers to commit to the needs of all stakeholders. Viewed as a major philosophical transition (even labeled a “tectonic shift” by some observers), the BRT statement ushered in a brave new world of contracting challenges involving a less familiar breed of agency costs, notably the agency costs of stakeholderism. To better understand our new contracting environment, we need to better understand the agency costs of stakeholderism. The transition from a monistic (shareholder) to a pluralistic (stakeholder) focus adds many complications. To try to make sense of the complications, we start small and simple—we consider one compensation contract from one firm. Specifically, we study the compensation contract for AT&T's CEO Mr. John Stankey. We gather detailed compensation contract data for the years 2018–2023. Delving deeply into AT&T's compensation structure, we use AT&T's contract as a model to identify and analyze specific examples of agency costs of stakeholderism. Lessons learned from dissecting AT&T's compensation contract should serve us well when diagnosing agency costs of stakeholderism in other contexts. Edmans et al. (2024) and Cohen et al. (2023) identify the need for studies such as ours that focus on firm-level contracting decisions. Cautioning that the performance impact of environmental and social initiatives is not unambiguously positive, Edmans et al. (2024) emphasize the urgency to thoroughly consider the unique factors of each firm's contracting environment. Furthermore, Edmans et al. (2024, p. 20) “highlights the importance of academic research taking a more granular or more situational approach.” Accordingly, our detailed, firm-level analysis will allow us to observe critical intricacies of AT&T's contracting structure that may have been undetected if not examined under the microscope of our granular, situational analysis. Our subsequent discussion and analysis of AT&T's very nuanced compensation structure provides further detail (such as to the potential opacity brought on by the addition of an ESG-based component of manager pay). The overall complexity of contemporary pay structure reinforces the conclusion by Larcker and Tayan (2023) that the intricacies of modern compensation arrangements can contribute to investor confusion. Even before the advent of widespread ESG-based pay Faulkender and Yang (2010) referred to the compensation-setting process as a “black box.” Today, given the additional challenge of identifying relevant and measurable ESG goals (and then being able to objectively assess performance in reaching those goals), that “black box” is increasingly resembling an Enigma machine. We hope that the insights from our in-depth investigation of the evolution of the AT&T compensation structure will help to crack the code inherent in many compensation arrangements and thus help us better understand the costs and benefits of this important contract.1 While focusing on the specifics of the AT&T compensation contract, our study may also provide greater insights regarding the generalities of financial contracting. Larcker and Tayan (2023), when identifying limitations of our understanding of corporate governance, alert us that “we do not know the economic ramifications of higher stakeholder orientation” (p. 5) and “we do not know the role that stakeholder interests should play in governance or how these should be prioritized relative to shareholder interests” (p. 5). Larcker and Tayan (2023) refer to such deficiencies as “gaping holes” in our knowledge of corporate governance. We will know more following our thorough evaluation of AT&T's compensation structure and our detailed consideration of agency costs of stakeholderism. Reaching a better understanding of the agency costs of stakeholderism will move us closer to the goal of Larcker and Tayan (2023, p. 5) of better understanding the “economic ramifications of higher stakeholder orientation.” Furthermore, foreshadowing knowledge to be gained from the analysis of agency costs of stakeholderism, Tirole (2001) predicted that the shift to a stakeholder society would require a rewriting of the rules of corporate governance and a reconfiguration of institutions to assuage decision-makers to internalize the welfare of stakeholders. Unfortunately, as we will discuss throughout our analysis, this rewriting and reconfiguring is challenging and has recently created vulnerabilities that are prone to exploitation by rent-seeking managers and other opportunists. We label the impact of this potential exploitation as the agency costs of stakeholderism. Our deep dive into AT&T's compensation contract will help us to better identify, measure, and manage these important, but we contend, under-analyzed contracting costs. Here's what we know about AT&T's recent compensation contracting efforts. Table 1 documents the components of AT&T's CEO compensation from 2018 to 2023. In bold font is the pay structure for 2021, the year of adoption of an incentive plan to pay an ESG-linked bonus to AT&T's CEO (Mr. Stankey). Table 1 presents data from several recent AT&T Summary Compensation Tables contained in the respective yearly proxies. The Summary Compensation Table presents the amounts and types of compensation paid to the CEO and other executives. We focus on CEO compensation, although compensation for other executives is included in the proxy disclosure. Year (Fiscal year) Table 1 shows that the CEO is paid a mix of salary, equity-based compensation, and non-equity incentive plan cash bonuses. The mix of pay components that are incentive-based (at-risk pay) should theoretically reward both short-term and long-term results. As explained in the footnotes and in the Compensation Discussion and Analysis (CD&A), salary is a fixed cash component of compensation, determined as a function of experience and skill, as well as market comparisons. Equity-based compensation is intended to motivate and reward managers to fulfill the long-term objectives of the company and “align executive and p. types of equity-based pay included in this contract, performance and The of the on the and also on on a measure, by a shareholder The of the also upon the performance of the AT&T The ESG bonus is included in the non-equity incentive AT&T to this plan in the proxy as the short-term incentive plan plan is on a of financial as well as ESG The of the non-equity incentive plan and cash are but these are for bonus The use of firms to from the that do not are under the of a is in such to make that the may be of or of as the CEO has the CEO compensation should not be the other some be as the pay from decisions. with the the may be the of a from a by the such CEO compensation to be from by that the and the have not a the adds as to how the bonus is is a value. We further recognize that such by for regarding the for in to the bonus are the for initiatives for the in this proxy to AT&T's proxy (p. the are on of with potential for or by the to pay with goals as of the bonus link to our p. and and initiatives and p. are of the referred to as by the the ESG bonus is there is additional regarding how the bonus is We emphasize that the of is As we with to the there are but there is also as to how the are greater the The is to contribute to agency costs of stakeholderism. and are from AT&T's We how these can be or We also how may contribute to agency costs of stakeholderism. Jensen and and all that the to the of ESG goals is a for agency of (and a for agency costs of stakeholderism). We know that corporate governance both and Our subsequent analysis suggests that AT&T's compensation allow for the potential for the agency costs of stakeholderism, the recent stakeholderism for to a the is pluralistic function that managers for Jensen (2001) that there are for the performance of managers with objectives under stakeholderism). to managers are to managers have to have the of and firms ESG goals to the is the in ESG The about will do that The is However, are to such of ESG data that (i.e., the a new of is that on to provide of environmental most in the more and (such as may also seek a of of environmental performance by the for by as of management AT&T that has the of such as the the and the on of this to be by a to be a The is that these have The as identified by is that those may not be for the specific firm. the but important, costs of this of (2024, p. that the to as from by a an of the to Accordingly, we the of the to these as to that of to financial in debt contracts (i.e., both provide benefits from but both costs from of should be as of the analysis of the agency costs of this that ESG will be to and to is that the use of ESG in executive compensation contracts will in of have also to provide firm-level of ESG major issue with these is and the ESG between and The may affect the of to et to ESG have a of et is another of less to more agency costs, and thus agency costs of stakeholderism. Further focusing on of and conclude that the use of ESG has a and and can be as we identify in our AT&T most of the ESG performance are is concern that are for the on financial In other the bonus may be from financial performance Cautioning of further Tirole that the to subject managers to is a of incentive However, goals are and subject to and that the and to from an to for managers to the of and of for evaluation pay for as a of may ESG-based compensation to if not thus further the agency costs of stakeholderism. In when performance is not with a and managers are not and not into and (i.e., if a what to the incentive to Therefore, may be that pay is not and may be paid of this to the agency costs of stakeholderism. that the of is upon of Tirole further the of a to the of a for by and and the theory that managers may be to to potentially stakeholders and shareholder in to the benefits of more and a more of represents an additional agency of stakeholderism. Another specific issue that is as the As formally articulated by Larcker et al. a ESG require many years to et et compensation are primarily on Our analysis of AT&T's compensation contracting suggests that AT&T has not this some insights as to the of this in the that incentive reward performance for (such as the Accordingly, as summarized by and and et al. (2023), ESG short-term costs, and managers may not be to the more (i.e., in financial performance from the ESG to the long-term environmental and social The from the that may of this represents another agency of stakeholderism. Our of the suggests to the of one is to to compensation on long-term if short-term are of the of to firms should compensation more to long-term for a from pay Edmans (2023) that compensation design should short-term and should pay structure with the of that managers for many As also by and and and Edmans (2023) that long-term are to motivate long-term (such as many of the and endeavors to the and to one to the is to shift compensation from short-term to to long-term of Our analysis of compensation contracting that AT&T has not this is to compensation from for to for (2024) that the challenge of ESG goals is between short-term and Our suggests that the between short-term and long-term is a of and on the Applying to ESG suggests that pay structure should to long-term compensation contracts should the of would the firm's a to long-term ESG However, when to on the theory to be but into and Edmans challenge the firm's to in terms of long-term goals are to Our analysis of the AT&T compensation contracts suggests that most firms to define specific that and is to in Accordingly, AT&T has to measurable to there is the agency costs of stakeholderism (such as this will The of and contribute to other of that may also to the agency costs of stakeholderism. that that endeavors may “a Specifically, Edmans et al. and and Jensen (2001) that managers may ESG initiatives to or often to the of shareholder with the ESG may provide additional benefits such as and or compensation Our study of AT&T's compensation contracting of all of these of agency costs of stakeholderism. Our study of ESG AT&T provides with In AT&T's proxy to ESG and this in Table shows the components of this ESG under that we there are in the Compensation Discussion Analysis of the that are in some with and and among different or such as the and among and in the are and such as of and and and of for among there and initiatives to AT&T such as the the and the among Table shows the of ESG with other The of ESG 2) is a of the number of ESG in the proxy all of AT&T's for ESG in the by a we this for AT&T in ESG to be a we will for ESG bonus As we further to identify and understand the agency of stakeholderism, we may also consider the firm's to in (i.e., as an of the Jensen and recognize that firms increasingly to interest are in as Jensen and of the of into the firm's contracting among the are the ESG would be social managers of and environmental The of (such as an of ESG may help to the and thus should help to make a more a for is of a agency in the manager the benefits of a more the shareholders the costs. 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We that a of this new world of is the benefits and the costs of stakeholderism, the agency costs that are the focus of this different of the ESG Edmans (2024) as those to upon the recent of for ESG to additional economic benefits (such as taking to an suggests that some is being a and we that one to shareholders to additional ESG-linked compensation, or to to compensation structure, that are to is that to in a bonus is the is so or the is to be so that can be by or the a conclusion of would not require to the there is concern that are for the on financial this of more such a bonus as from financial some have that the for executive compensation to ESG is to financial performance et al. (2024) that firms to do by financial performance the additional that the of ESG our and that of et al. suggests the Our detailed analysis of compensation contracting AT&T provides for many of the in these We start with a of ESG 1 provides the of ESG for of in the to by then to by for a of years then to and as of with the in the We that the in the of the ESG-linked As the establishing of a bonus plan that is to ESG shows that the firm is the that the may the company more of the of the We further the in to in that AT&T's ESG so the year ESG ESG what is to us is there to be between the ESG and the ESG-based compensation paid to AT&T's Table we that the CEO paid a ESG-based bonus when more ESG in and The CEO also paid a ESG-based bonus when less ESG in year in AT&T to a ESG is more about the ESG is that is one ESG performance can be (i.e., the ESG from in to in but then the in ESG to be the CEO of we in Table and and financial for AT&T cash and cash as well as of market and provide of 2021, the year that AT&T the ESG The the year following the ESG bonus shows AT&T's performance the Table provides on the ESG AT&T that the for the but Mr. of that p. 2021, the under the pay not or We seek to such and is how AT&T to the for ESG The of the for all the on the the of the new AT&T to use of to the To provide a of to ESG AT&T that have of such by for the on most and so a new from the firms provide what executives paid for the in addition to the pay Mr. data regarding compensation is to the pay We that the of the is a is and is ESG-based may be used to provide compensation when other components of pay to be from the data that and by the recent performance of AT&T's provided compensation the However, the from the the ESG the the of overall compensation by the pay may be if in the ESG bonus may be used to make for in other components of to in another of agency we may this to our of to agency costs of stakeholderism. In Table we consider the of AT&T's compensation structure and to that of the firm in the We focus on pay the ESG-based of the in AT&T's pay a of that upon the advent of ESG-based pay in AT&T's initial of ESG-based pay in in an of pay as of compensation (i.e., in in suggests that AT&T a to the ESG incentive-based pay in with in and financial market We our analysis to the of the in Table of AT&T's pay that the to that of the a the years of the ESG bonus of Applying a to the data the incentive incentive 2024 proxy is 2024 is 2024 is 2024 is on the between AT&T's performance and the CEO compensation, we can from and that the and financial performance the years in the paid from that AT&T's has the years of the in the would the of of would and the of would be However, the ESG-linked bonus as an to the in of the equity-based we of agency costs from managers an of We another of agency from managers an of Specifically, the AT&T has us to a new of ESG-based is and is for or the compensation ESG-linked compensation may be when compensation is provides an advantage to managers by taking the of Agency costs of stakeholderism are the costs to and arising from conflicts of interest that emerge when moving from shareholder primacy to stakeholder primacy. Our of AT&T's compensation contract and our subsequent of agency costs of stakeholderism may insights as to ESG has to As in the 2024 Spring edition of this journal, of Specifically, Edmans (2024) to fulfill of by and Chew (2024) that the of ESG may the Denis (2024) that the stakeholder a Accordingly, we seek to by economic from agency theory to and better understand costs that may have from have and have to emerge from these we that agency costs of stakeholderism have to the in investor of ESG and that the management of these costs will primarily To provide detailed we study the CEO compensation contract for AT&T and identify specific agency costs of stakeholderism, as in to ESG-based bonuses. We are by how this of ESG has so of management one of is the of on AT&T that short-term incentive paid in are on of with potential for or by the to pay with However, a of the proxy shows the goals to ESG to be if not further to the agency costs of stakeholderism. rules in will this be another to The with that would be in the agency costs of stakeholderism. Jensen (2001) that that managers should the interests of all stakeholders with those of is by the of executives to the between the of the firm's if to be to managers to Jensen (2001) if there is approach to make there is to Accordingly, managers are to in of shareholder wealth. The can be agency costs of stakeholderism. our we provide and analysis that the and of agency costs of stakeholderism. our on of our contracting environment, we regarding the of the financial to and these agency We hope that our of the agency costs of stakeholderism will help in to important contracting that to arise as we seek the between shareholder and stakeholder primacy. AT&T's ESG and as of