We model the determination of management compensation through the strategic interaction among outside
shareholders, managers, and corporate boards. The board sets both regular incentive compensation and discretionary
special compensation unrelated to performance. We show that shareholder value maximising compensation
plans may feature incentive compensation that is not monotone in performance and discretionary payments
unrelated to performance. Manager oriented boards may transfer wealth to managers using compensation plans
that feature a higher pay to performance relation and also exploit the discretionary compensation to enrich management.
Full delegation of authority to the board, which insulates the board from shareholder outrage, may be
optimal even if the likelihood of managerial control is high. However, in some cases, imposing charter restrictions
on discretionary compensation is optimal. Shareholder democracy, by exposing board members to outrage
costs, creates additional sources of distortion as it both induces management-oriented boards to distort operating
policy to mask wealth transfers and shareholder-oriented boards to forego optimal compensation designs to avoid
shareholder suspicion.