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Has Moral Hazard Become a More Important Factor in Managerial Compensation?

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  • George-Levi Gayle
  • Robert A. Miller
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    Abstract

    We estimate a principal-agent model of moral hazard with longitudinal data on firms and managerial compensation over two disjoint periods spanning 60 years to investigate increased value and variability in managerial compensation. We find exogenous growth in firm size largely explains these secular trends in compensation. In our framework, exogenous firm size works through two channels. First, conflicts of interest between shareholders and managers are magnified in large firms, so optimal compensation plans are now more closely linked to insider wealth. Second, the market for managers has become more differentiated, increasing the premium paid to managers of large versus small firms. (JEL D82, L25, M12, M52)

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    Bibliographic Info

    Article provided by American Economic Association in its journal American Economic Review.

    Volume (Year): 99 (2009)
    Issue (Month): 5 (December)
    Pages: 1740-69

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    Handle: RePEc:aea:aecrev:v:99:y:2009:i:5:p:1740-69

    Note: DOI: 10.1257/aer.99.5.1740
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    1. John M. Abowd & David S. Kaplan, 1999. "Executive Compensation: Six Questions that Need Answering," NBER Working Papers 7124, National Bureau of Economic Research, Inc.
    2. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
    3. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
    4. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February.
    5. Garen, John E, 1994. "Executive Compensation and Principal-Agent Theory," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1175-99, December.
    6. Jensen, M.C. & Murphy, K.J., 1988. "Performance Pay And Top Management Incentives," Papers 88-04, Rochester, Business - Managerial Economics Research Center.
    7. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
    8. Mathias Dewatripont & Patrick Bolton, 2005. "Contract theory," ULB Institutional Repository 2013/9543, ULB -- Universite Libre de Bruxelles.
    9. Oliver E. Williamson, 1967. "Hierarchical Control and Optimum Firm Size," Journal of Political Economy, University of Chicago Press, vol. 75, pages 123.
    10. Cuñat, Vicente & Guadalupe, Maria, 2006. "Globalization and the Provision of Incentives Inside the Firm," CEPR Discussion Papers 5950, C.E.P.R. Discussion Papers.
    11. Masson, Robert Tempest, 1971. "Executive Motivations, Earnings, and Consequent Equity Performance," Journal of Political Economy, University of Chicago Press, vol. 79(6), pages 1278-92, Nov.-Dec..
    12. Kevin J. Murphy & Ján Zábojník, 2004. "CEO Pay and Appointments: A Market-Based Explanation for Recent Trends," American Economic Review, American Economic Association, vol. 94(2), pages 192-196, May.
    13. Kevin J. Murphy & Jan Zabojnik, 2006. "Managerial Capital and the Market for CEOs," Working Papers 1110, Queen's University, Department of Economics.
    14. Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Really Paid Like Bureaucrats?," NBER Working Papers 6213, National Bureau of Economic Research, Inc.
    15. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-76, April.
    16. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
    17. Margiotta, Mary M & Miller, Robert A, 2000. "Managerial Compensation and the Cost of Moral Hazard," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(3), pages 669-719, August.
    18. Peter F. Kostiuk, 1990. "Firm Size and Executive Compensation," Journal of Human Resources, University of Wisconsin Press, vol. 25(1), pages 90-105.
    19. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
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    Cited by:
    1. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," NBER Working Papers 16585, National Bureau of Economic Research, Inc.
    2. Edmans, Alex & Gabaix, Xavier, 2010. "Risk and CEO Market: Why Do Some Large Firms Hire Highly-Paid, Low-Talent CEOs?," Working Papers 10-17, University of Pennsylvania, Wharton School, Weiss Center.
    3. Hsuan-Chi Chen & Robert Fok & Chiuling Lu, 2011. "An Analysis of Lockups in REIT IPOs," The Journal of Real Estate Finance and Economics, Springer, vol. 43(3), pages 359-384, October.
    4. Yim, Soojin, 2013. "The acquisitiveness of youth: CEO age and acquisition behavior," Journal of Financial Economics, Elsevier, vol. 108(1), pages 250-273.
    5. Alexander Pepper & Julie Gore, 2013. "The economic psychology of incentives: an international study of top managers," LSE Research Online Documents on Economics 51655, London School of Economics and Political Science, LSE Library.
    6. Giannetti, Mariassunta, 2011. "Serial CEO incentives and the structure of managerial contracts," Journal of Financial Intermediation, Elsevier, vol. 20(4), pages 633-662, October.
    7. Oyer, Paul & Schaefer, Scott, 2011. "Personnel Economics: Hiring and Incentives," Handbook of Labor Economics, Elsevier.
    8. Allgood, Sam & Farrell, Kathleen A. & Kamal, Rashiqa, 2012. "Do boards know when they hire a CEO that is a good match? Evidence from initial compensation," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1051-1064.
    9. Brenner, Steffen, 2011. "On the irrelevance of insider trading for managerial compensation," European Economic Review, Elsevier, vol. 55(2), pages 293-303, February.

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