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Do CEOs Set Their Own Pay? The Ones Without Principals Do

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  • Marianne Bertrand
  • Sendhil Mullainathan

Abstract

We empirically examine two competing views of CEO pay. In the contracting view, pay is used to solve an agency problem: the compensation committee optimally chooses pay contracts which give the CEO incentives to maximize shareholder wealth. In the skimming view, pay is the result of an agency problem: CEOs have managed to capture the pay process so that they set their own pay, constrained somewhat by the availability of cash or by a fear of drawing shareholders' attention. To distinguish these views, we first examine how CEO pay responds to luck, observable shocks to performance beyond the CEO's control. Using several measures of luck, such as changes in oil price for the oil industry, we find substantial pay for luck. Pay responds about as much to a lucky' dollar as to a general dollar. Most importantly, we find that better governed firms pay their CEOs less for luck. Our second test examines how much CEOs are charged for the options they are granted. Since options never appear on balance sheets, they might offer an appealing way to skim. Here again we find a crucial role for governance: CEOs in better governed firms are charged more for the options they are given. These results suggest that both views of CEO pay matter. In poorly governed firms, the skimming view fits better (pay for luck and little charge for options) while in well governed firms, the contracting view fits better (filtering out of luck and charging for options).

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7604.

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Date of creation: Mar 2000
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Publication status: published as Bertrand, Marianne and Sendhil Mullainathan. "Are CEOs Rewarded For Luck? The Ones Without Principles Are," Quarterly Journal of Economics, 2001, v116(3,Aug), 901-932.
Handle: RePEc:nbr:nberwo:7604

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Cited by:
  1. Julio Segura, 2004. "Competencia, disciplina de mercado y regulación en presencia de conflictos de interés en las empresas," Hacienda Pública Española, IEF, IEF, vol. 169(2), pages 135-170, June.
  2. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 33(1), pages 3-42, February.
  3. DiNardo, John & Hallock, Kevin F. & Pischke, Jörn-Steffen, 2000. "Unions and the Labor Market for Managers," IZA Discussion Papers 150, Institute for the Study of Labor (IZA).
  4. Thomas Piketty & Emmanuel Saez, 2001. "Income Inequality in the United States, 1913-1998 (series updated to 2000 available)," NBER Working Papers 8467, National Bureau of Economic Research, Inc.
  5. Wolfers, Justin, 2002. "Are Voters Rational? Evidence from Gubernatorial Elections," Research Papers, Stanford University, Graduate School of Business 1730, Stanford University, Graduate School of Business.
  6. Vicente Cuñat & María Guadalupe, 2004. "Executive Compensation and Product Market Competition," CEP Discussion Papers, Centre for Economic Performance, LSE dp0617, Centre for Economic Performance, LSE.
  7. Paul Oyer, 2000. "Why Do Firms Use Incentives that Have No Incentive Effects?," Econometric Society World Congress 2000 Contributed Papers, Econometric Society 1440, Econometric Society.
  8. Art Durnev & Sergei Guriev, 2007. "The Resource Curse: A Corporate Transparency Channel," Working Papers w0108, Center for Economic and Financial Research (CEFIR).
  9. Jenter, Dirk, 2004. "Executive Compensation, Incentives, and Risk," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4466-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. Pierre-André Chiappori & Bernard Salanié, 2002. "Testing Contract Theory : A Survey of Some Recent Work," Working Papers, Centre de Recherche en Economie et Statistique 2002-11, Centre de Recherche en Economie et Statistique.
  11. Basov Suren, 2003. "Incentives for Boundedly Rational Agents," The B.E. Journal of Theoretical Economics, De Gruyter, De Gruyter, vol. 3(1), pages 1-16, June.
  12. Goergen, Marc & Renneboog, Luc, 2011. "Managerial compensation," Journal of Corporate Finance, Elsevier, Elsevier, vol. 17(4), pages 1068-1077, September.
  13. Sautner, Zacharias & Weber, Martin, 2005. "Corporate Governance and the Design of Stock Option Programs," Sonderforschungsbereich 504 Publications, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim 05-32, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.

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