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Why Has CEO Pay Increased So Much?

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Author Info
Xavier Gabaix () (Massachusetts Institute of Technology)
Augustin Landier

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Abstract

This paper develops a simple competitive model of CEO pay. It appears to explain much of the rise in CEO compensation in the US economy, without assuming managerial entrenchment, mishandling of options, or theft. CEOs have observable managerial talent and are matched to assets in a competitive assignment model. The marginal impact of a CEO's talent is assumed to increase with the value of the assets under his control. Under very general assumptions, using results from extreme value theory, the model determines the level of CEO pay across firms and over time, and the pay-sensitivity relations. We predict that the level of CEO compensation should increase one for one with the average market capitalization of large firms in the economy. Therefore, the eight-fold increase of CEO pay between 1980 and 2000 can be fully attributed to the increase in market capitalization of large US companies. The model predicts the cross-section Cobb-Douglass relation between pay and firm size and can be used to study other large changes at the top of the income distribution, and offers a benchmark for calibratable corporate finance

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 518.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:518

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Related research
Keywords: Executive compensation; wage distribution; Pareto distribution; wage inequality; assignment; incentives; pay performance sensitivity;

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Find related papers by JEL classification:
D2 - Microeconomics - - Production and Organizations
D3 - Microeconomics - - Distribution
G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  5. Sherwin Rosen, 1990. "Contracts and the Market for Executives," NBER Working Papers 3542, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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    Other versions:
  7. Baker, George P & Jensen, Michael C & Murphy, Kevin J, 1988. " Compensation and Incentives: Practice vs. Theory," Journal of Finance, American Finance Association, vol. 43(3), pages 593-616, July. [Downloadable!] (restricted)
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  18. Lucian Arye Bebchuk & Jesse M. Fried, 2003. "Executive Compensation as an Agency Problem," NBER Working Papers 9813, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  22. Andrei Shleifer, 2004. "Does Competition Destroy Ethical Behavior?," NBER Working Papers 10269, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  23. Paul Gompers & Joy Ishii & Andrew Metrick, 2003. "Corporate Governance And Equity Prices," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 107-155, February. [Downloadable!] (restricted)
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  24. J. M. C. Santos Silva & Silvana Tenreyro, 2006. "The Log of Gravity," The Review of Economics and Statistics, MIT Press, vol. 88(4), pages 641-658, 09. [Downloadable!] (restricted)
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  25. 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. [Downloadable!]
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  27. Jess Benhabib & Alberto Bisin, 2006. "The distribution of wealth and redistributive policies," 2006 Meeting Papers 368, Society for Economic Dynamics. [Downloadable!]
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  29. Nancy L. Rose & Andrea Shepard, 1997. "Firm Diversification and CEO Compensation: Managerial Ability or Executive Entrenchment?," RAND Journal of Economics, The RAND Corporation, vol. 28(3), pages 489-514, Autumn. [Downloadable!] (restricted)
  30. Xavier Gabaix & Parameswaran Gopikrishnan & Vasiliki Plerou & H. Eugene Stanley, 2006. "Institutional Investors and Stock Market Volatility," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 461-504, May. [Downloadable!] (restricted)
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  31. George P. Baker & Brian J. Hall, 2004. "CEO Incentives and Firm Size," Journal of Labor Economics, University of Chicago Press, vol. 22(4), pages 767-798, October. [Downloadable!]
  32. Bebchuk, Lucian Arye & Fried, Jesse, 2003. "Executive Compensation as an Agency Problem," CEPR Discussion Papers 3961, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  36. Conyon, Martin J & Murphy, Kevin J, 2000. "The Prince and the Pauper? CEO Pay in the United States and United Kingdom," Economic Journal, Royal Economic Society, vol. 110(467), pages F640-71, November. [Downloadable!] (restricted)
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  51. 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. [Downloadable!] (restricted)
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  53. Inderst, Roman & Mueller, Holger M, 2005. "Keeping the Board in the Dark: CEO Compensation and Entrenchment," CEPR Discussion Papers 5315, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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