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Why Has CEO Pay Increased So Much?

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  • Xavier Gabaix

    () (Massachusetts Institute of Technology)

  • Augustin Landier

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

Suggested Citation

  • Xavier Gabaix & Augustin Landier, 2006. "Why Has CEO Pay Increased So Much?," 2006 Meeting Papers 518, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:518
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    Keywords

    Executive compensation; wage distribution; Pareto distribution; wage inequality; assignment; incentives; pay performance sensitivity;

    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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