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

  • George-Levi Gayle
  • Robert A. Miller

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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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. Oliver E. Williamson, 1967. "Hierarchical Control and Optimum Firm Size," Journal of Political Economy, University of Chicago Press, vol. 75, pages 123.
  2. Mathias Dewatripont & Patrick Bolton, 2005. "Contract theory," ULB Institutional Repository 2013/9543, ULB -- Universite Libre de Bruxelles.
  3. Rajesh Aggarwal & Andrew A. Samwick, 1998. "The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation," NBER Working Papers 6634, National Bureau of Economic Research, Inc.
  4. Jensen, M.C. & Murphy, K.J., 1988. "Performance Pay And Top Management Incentives," Papers 88-04, Rochester, Business - Managerial Economics Research Center.
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  7. Kevin J. Murphy & Jan Zabojnik, 2006. "Managerial Capital and the Market for CEOs," Working Papers 1110, Queen's University, Department of Economics.
  8. 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.
  9. George-Levi Gayle & Robert Miller, . "Identifying and Testing Models of Managerial Compensations," GSIA Working Papers 2009-E7, Carnegie Mellon University, Tepper School of Business.
  10. 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..
  11. Brian J. Hall & Jeffrey B. Liebman, 1997. "Are CEOs Really Paid Like Bureaucrats?," NBER Working Papers 6213, National Bureau of Economic Research, Inc.
  12. 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.
  13. Fudenberg, Drew & Holmstrom, Bengt & Milgrom, Paul, 1990. "Short-term contracts and long-term agency relationships," Journal of Economic Theory, Elsevier, vol. 51(1), pages 1-31, June.
  14. Cuñat, Vicente & Guadalupe, Maria, 2006. "Globalization and the Provision of Incentives Inside the Firm," CEPR Discussion Papers 5950, C.E.P.R. Discussion Papers.
  15. Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
  16. John M. Abowd & David S. Kaplan, 1999. "Executive Compensation: Six Questions That Need Answering," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 145-168, Fall.
  17. Peter F. Kostiuk, 1990. "Firm Size and Executive Compensation," Journal of Human Resources, University of Wisconsin Press, vol. 25(1), pages 90-105.
  18. 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.
  19. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  20. 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.
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