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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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  • Marianne Bertrand & Sendhil Mullainathan, 2000. "Do CEOs Set Their Own Pay? The Ones Without Principals Do," NBER Working Papers 7604, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:7604
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    Cited by:

    1. Cannizzaro, Anthony P. & Weiner, Robert J., 2015. "Multinational investment and voluntary disclosure: Project-level evidence from the petroleum industry," Accounting, Organizations and Society, Elsevier, vol. 42(C), pages 32-47.
    2. Cuñat, Vicente & Guadalupe, Maria, 2004. "Executive compensation and product market competition," LSE Research Online Documents on Economics 19985, London School of Economics and Political Science, LSE Library.
    3. Hall, Brian J. & Murphy, Kevin J., 2002. "Stock options for undiversified executives," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 3-42, February.
    4. Paul Oyer, 2004. "Why Do Firms Use Incentives That Have No Incentive Effects?," Journal of Finance, American Finance Association, vol. 59(4), pages 1619-1650, August.
    5. Basov Suren, 2003. "Incentives for Boundedly Rational Agents," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 3(1), pages 1-16, June.
    6. Wolfers, Justin, 2002. "Are Voters Rational? Evidence from Gubernatorial Elections," Research Papers 1730, Stanford University, Graduate School of Business.
    7. Durnev, Artyom & Guriev, Sergei, 2007. "The Resource Curse: A Corporate Transparency Channel," CEPR Discussion Papers 6547, C.E.P.R. Discussion Papers.
    8. Jenter, Dirk, 2004. "Executive Compensation, Incentives, and Risk," Working papers 4466-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    9. Gloria Cuevas-Rodriguez & Jaime Guerrero-Villegas & Ramón Valle-Cabrera, 2014. "Privatization effects on corporate governance, strategy and compensation systems," Working Papers 14.03, Universidad Pablo de Olavide, Department of Business Organization and Marketing (former Department of Business Administration).
    10. Sautner, Zacharias & Weber, Martin, 2005. "Corporate governance and the design of stock option programms," Papers 05-32, Sonderforschungsbreich 504.
    11. Dinardo, John & Hallock, Kevin F & Pischke, Jörn-Steffen, 2000. "Unions And The Labour Market For Managers," CEPR Discussion Papers 2418, C.E.P.R. Discussion Papers.
    12. Chander Shekhar & Geof Stapledon, 2007. "Governance Structures of Initial Public Offerings in Australia," Corporate Governance: An International Review, Wiley Blackwell, vol. 15(6), pages 1177-1189, November.
    13. 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.
    14. Pierre-André Chiappori & Bernard Salanié, 2002. "Testing Contract Theory : A Survey of Some Recent Work," Working Papers 2002-11, Center for Research in Economics and Statistics.
    15. Goergen, Marc & Renneboog, Luc, 2011. "Managerial compensation," Journal of Corporate Finance, Elsevier, vol. 17(4), pages 1068-1077, September.
    16. Julio Segura, 2004. "Competencia, disciplina de mercado y regulación en presencia de conflictos de interés en las empresas," Hacienda Pública Española, IEF, vol. 169(2), pages 135-170, June.
    17. Uwe Jirjahn, 2016. "Works Councils and Employer Attitudes toward the Incentive Effects of HRM Practices," Research Papers in Economics 2016-07, University of Trier, Department of Economics.

    More about this item

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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