Are carrots better than sticks? Yes, is the assumption underlying pay-for-performance as a means of corporate governance. The economic theory behind pay-for-performance is that managers will maximize a firm’s value if their interests are aligned with those of the owners. The implementation of performance-based pay schemes, however, often leaves much to be desired, and psychological research suggests incentive compensation can even have detrimental effects on performance.

Incentive pay analyses have generally focused on normal business operations. There has been little written about the unique problems posed by bankruptcy, where ownership often shifts and the debtor operates under court and creditor supervision. Most proposals for improving corporate governance in bankruptcy advocate fine-tuning various creditor and shareholder constituencies’ roles in the reorganization process. There has been little consideration of management incentives in bankruptcy. Yair Listokin’s article is thus an important attempt to apply the insights of corporate finance and refocus the corporate governance debate in bankruptcy from the sticks of traditional corporate governance—monitoring by directors, creditors, the United States Trustee, and the court—to the carrots of incentive compensation.

The Problematic Case for Incentive Compensation in Bankruptcy