Question

Consider the following article from the January 17, 2020 edition of the Wall Street Journal entitled "Morgan Stanley Cuts CEO James Gorman’s Bonus"

Morgan Stanley paid its chief executive, James Gorman, $27 million for his work in 2019, a pay cut for a year when the bank’s revenue hit a record but its shares lagged behind those of rivals.

Mr. Gorman earned about $19 million in Morgan Stanley shares and another roughly $8 million in cash, including salary and bonus, according to a Friday securities filing.

The 61-year-old was already among the highest-paid U.S. bank bosses. His 2018 pay package, worth about $29 million, was topped only by JPMorgan Chase & Co.’s James Dimon, who runs a bank that is three times the size of Morgan Stanley and vastly more complex.

Mr. Gorman earned a base salary of $1.5 million, the same as a year ago; a cash bonus of $6.4 million, down from $6.9 million a year ago; $12.8 million in stock that is linked to how well the bank does over the next few years; and another $6.4 million in shares that he’ll collect regardless of performance.

At the urging of shareholders and regulators, banks since the financial crisis have tied more of their executives’ pay to performance and deferred more of it into the future.

Morgan Stanley in 2019 posted an annual profit of $9 billion on a record $41 billion revenue. Mr. Gorman has delivered on financial metrics he set out to investors, including minimum profitability in its wealth-management division and firmwide return targets. On Thursday, he set new targets—though some analysts said they weren’t ambitious enough.

In setting Mr. Gorman’s pay, the company said that it took into account his long-term strategy and the bank’s “strong financial performance.”

Shares of Morgan Stanley gained 26% in 2019, lagging behind the S&P 500 and most of its big-bank peers. It is off to a stronger start this year, gaining 6.6% Thursday in its biggest single-day gain since the 2016 presidential election.

Who is the agent in this situation? Who are the principals? Use agency theory to explain the motivation behind tying Mr. Gorman's pay to performance.

Answer 1

The agent in this situation is Mr. James Gorman.

The principals are the shareholders of Morgan Stanley. This is because they are the owners of the company.

As per the agency theory there exists disputes with regards to priorities of the principals and the agent. The decision making authority is given to the agent by the principals and this can lead to difference of opinions as well as difference in priorities and interests. The agent is the decision maker but the risk is borne by the principals i.e. the shareholders.

The motivation behind tying Mr. Gorman's pay to performance was to align his interests with that of the interests of the principals. The principals want that their company’s share price never lag behind those of their rival’s shares and should in fact outperform the market index which in this case is S&P 500. By tying Mr. Gorman's pay to performance the shareholders are ensuring that Mr. Gorman will have a direct interest to increase the company’s share prices in future in a manner that the company’s stock outperforms its rivals and the broader market. This action will align the interest of the principals (shareholders) and the agent (the CEO).