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CEO pay and the market for CEOs

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  • Antonio Falato
  • Dan Li
  • Todd Milbourn
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    Abstract

    Competitive sorting models of the CEO labor market (e.g., Edmans, Gabaix and Landier (2009)) predict that differences in CEO productive abilities, or "talent", should be an important determinant of CEO pay. However, measuring CEO talent empirically represents a major challenge. In this paper, we document reliable evidence of pay for CEO credentials and argue that the evidence is consistent with models of the CEO labor market. Our main finding is that boards' compensation decisions reward several reputational, career, and educational credentials of CEOs, with newly-appointed CEOs earning a 5 percent ($280,000) total pay premium for each decile improvement in the distribution of these credentials. Consistent with boards using credentials as publicly-observable signals of CEO abilities, we show that pay for credentials displays key cross-sectional features predicted by theory, such as convexity in credentials and complementarity with firm size. Our main finding is robust to a battery of identification tests that address selectivity and endogeneity concerns, including instrumental variables estimates and controlling for firm and CEO fixed effects. We also show that credentials capture variation in CEO human capital that is different from lifetime work experience, and are positively related to long-term firm performance and board monitoring, which helps to distinguish our results from alternative stories based on CEO general human capital, hype, and entrenchment. Overall, our findings suggest that sorting considerations in the CEO labor market are an important determinant of CEO pay. Our results also suggest that the rise in CEO pay over the last decades may owe at least in part to a rise in the CEO talent premium.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2012-39.

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    Date of creation: 2012
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    Handle: RePEc:fip:fedgfe:2012-39

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    References

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    1. Guadalupe, Maria, 2005. "Product Market Competition, Returns to Skill and Wage Inequality," IZA Discussion Papers 1556, Institute for the Study of Labor (IZA).
    2. Becker, Bo & Cronqvist, Henrik & Fahlenbrach, Rüdiger, 2008. "Estimating the Effects of Large Shareholders Using a Geographic Instrument," SIFR Research Report Series 64, Institute for Financial Research.
    3. Carola Frydman & Dirk Jenter, 2010. "CEO Compensation," CESifo Working Paper Series 3277, CESifo Group Munich.
    4. Harman, Harry H., 1976. "Modern Factor Analysis," University of Chicago Press Economics Books, University of Chicago Press, edition 3, number 9780226316529, February.
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    9. Robert C. Feenstra & John Romalis & Peter K. Schott, 2002. "U.S. Imports, Exports, and Tariff Data, 1989-2001," NBER Working Papers 9387, National Bureau of Economic Research, Inc.
    10. Kevin J. Stiroh, 2002. "Information Technology and the U.S. Productivity Revival: What Do the Industry Data Say?," American Economic Review, American Economic Association, vol. 92(5), pages 1559-1576, December.
    11. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
    12. John R. Graham & Si Li & Jiaping Qiu, 2011. "Managerial Attributes and Executive Compensation," NBER Working Papers 17368, National Bureau of Economic Research, Inc.
    13. Marko Tervio, 2008. "The Difference That CEOs Make: An Assignment Model Approach," American Economic Review, American Economic Association, vol. 98(3), pages 642-68, June.
    14. Dan A. Black & Jeffrey A. Smith, 2006. "Estimating the Returns to College Quality with Multiple Proxies for Quality," Journal of Labor Economics, University of Chicago Press, vol. 24(3), pages 701-728, July.
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