Why Has CEO Pay Increased So Much
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Why Has CEO Pay Increased So Much
WHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Much develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO s pay depends on both the size of his firm, and the aggregate firm size. The model determines the level Of CEO pay across firms and ov Why Has CEO Pay Increased So Mucher time, offering a benchmark for calibratable corporate finance. We find a very small dispersion in CEO talent, which nonetheless justifies large payWhy Has CEO Pay Increased So Much
differences. In recent decades at least, the size of large firms explains many of the patterns in CEO pay. across firms, over time, and between countWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchattributed to the six-fold increase m market capitalization of large companies during that period.Keywords: Executive compensation, wage distribution, corporate governance. Roberts' law. Zipf's law. scaling, extreme value theory, superstars, calibratable corporate finance.JEL codes: D2. D3. G34, J3" Why Has CEO Pay Increased So MuchWe thank Hae Jin Chung and Jose Tessada for excellent research assistance. For helpful comments, we thank our two editors, two referees. Daron AcemoglWhy Has CEO Pay Increased So Much
u. Tobias Adrian. Yacine Ait-Sahalia. George Baker. Lucian Bebchuk. Gary Becker. Olivier Blanchard. Ian Dew-Becker. Alex Edmans. Bengt Holmstrom. ChadWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchimer. Jeremy Stein. Marko Tervio. David Yennack. Wei Xiong and seminar participants at Berkeley. Brown. Chicago. Duke. Harvard. London School of Economics. Minnesota Macro Workshop. MIT. NBER. New York University. Princeton. Society of Economic Dynamics. Stanford. University of Southern California. Why Has CEO Pay Increased So MuchWharton. We thank Carols Frydman and Kevin J. Murphy tor their data. XG thanks the NSF (Human and Social Dynamics grant 0527Õ1S) for financial supportWhy Has CEO Pay Increased So Much
.1I. IntroductionThis paper proposes a simple competitive model of CEO compensation. It is tractable and calibratable. CEOs have different levels of mWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Much his control. The model generates testable predictions about CEO pay across firms, over time, and between countries. Moreover, a benchmark specification of the model proposes that the recent rise in CEO compensation is an efficient equilibrium response to the increase in the market value of firms, r Why Has CEO Pay Increased So Muchather than resulting from agency issues.In our equilibrium model, the best CEOs manage the largest firms, as this maximizes their impact and economicWhy Has CEO Pay Increased So Much
efficiency. The paper extends earlier work (e.g., Lucas [1978]; Rosen [1981]. [1982], 1992]; Sattinger [1993]: Tervio [2003]). by drawing from extremeWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchform without loss of generality, and to generate concrete testable predictions.Our central equation (Eq. 14) predicts that a CEO's equilibrium pay is increasing with both the size of his firm and the size of the average firm in the economy. Our model also sheets light on cross-country differences in Why Has CEO Pay Increased So Much compensation. It predicts that countries experiencing a lower rise in firm value than the U.S. should also have experienced lower executive compensatWhy Has CEO Pay Increased So Much
ion growth, which is consistent with European evidence (e.g.. Abowd and Bognanno [1995]: and Conyon and Murphy [2000]). Our tentative evidence (hamperWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchn can be explained by differences in firm size.1Finally, we offer a calibration of the model, which could be useful in guiding future quantitative models of corporate finance. The main surprise is that the dispersion of CEO talent distribution appeared to be extremely small at the top. If we rank CE Why Has CEO Pay Increased So MuchOs by talent, and replace the CEO number 250 by the number one CEO. the value of his firm will increase by only 0.016%. These very small differences iWhy Has CEO Pay Increased So Much
n talent translate into considerable compensation differentials, as they are magnified by firm size. Indeed, the same calibration delivers that CEO nuWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchon. A secondary contribution is that the model allows for a quantitative explanation for the rise in CEO pay since the 1970s. Our benchmark calibration delivers the following explanation. The six-fold increase in CEO pay between 1980 and 2003 can be attributed to the six-fold increase in market capi Why Has CEO Pay Increased So Muchtalization of large U.S. companies during that period. When stock market valuations increase by 500%. under constant returns to scale, CEO "productiviWhy Has CEO Pay Increased So Much
ty" increases by 500%. and’This analysis applies only if one assumes national markets tor executive talent and not an integrated national market. The WHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchr interpretations (discussed in section V.E) are reasonable. Ill particular, the model highlights contagion as another potential source of increased compensation. If a small fraction of firms decide to pay more than the other firms (perhaps because of bad corporate governance), the pay of all CEOs c Why Has CEO Pay Increased So Muchan rise by a large amount in general equilibrium.We now explain how our theory relates to prior work. First and foremost, this paper is in the spiritWhy Has CEO Pay Increased So Much
of Rosen [1981]. We use extreme value theory to make analytical progress in the economics of superstars. More recently. Ten io 2003] is the first papeWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchs and any other market imperfections. Tervio derives the classic (Sattinger [1993]) assignment equation 5 in rhe context of CEO markets, and uses it to evaluate empirically the surplus created by CEO talent. He quantifies the differences between top CEO talent, in a way we derail in section ĨV.B. Wh Why Has CEO Pay Increased So Muchile Tervio ’2003] infers the distribution of talent from the observed joint distribution of pay and market value, in the present paper, we start by miWhy Has CEO Pay Increased So Much
xing extreme value theory, the literature on the size distribution of firms, and the assignment approach to solve for equilibrium CEO pay in closed foWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchse of firm size as a potentially major explanatory variable can be compared with the three types of economic arguments that have been proposed to explain this phenomenon. These three types of theories are based on interesting comparative static insights and contribute to our understanding of cross-s Why Has CEO Pay Increased So Muchectional variations in CEO pay and changes in the composition of CEO compensation. Yet. when it conies to the time-series of CEO pay levels, it remainWhy Has CEO Pay Increased So Much
s difficult to estimate what fraction of the massive 500% real increase since the 1980s can be explained by each of these theories, as their comparatiWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchh those earlier theories to obtain a fuller account of the evolution of CEO pay.The first explanation attributes the increase in CEO compensation to the widespread adoption of compensation packages with high powered incentives since the late 1980s. Both academics and shareholder activists have been Why Has CEO Pay Increased So Muchpushing throughout the 1990s for stronger and more market based managerial incentives (e.g.. Jensen and Murphy [1990]). According to Tnderst and MuellWhy Has CEO Pay Increased So Much
er [2005] and Dow and Raposo [2005] higher incentives have become optimal due to increased volatility in the business environment faced by firms. AccoWHY HAS CEO PAY INCREASED so MUCH?*Xavier Gabaix and Augustin LandierApril 9. 2007Forthcoming in the Quarterly Journal of EconomicsAbstractThis paper Why Has CEO Pay Increased So Muchnsation.Tn rhe presence of limited liability and/or risk-aversion, increasing performance sensitivity requires a rise in the dollar value of compensation to maintain CEO participation. Holmstrom and Kaplan [2001. 2003] link the rise of compensation value to the rise in stock based compensation3https Why Has CEO Pay Increased So Much://khothuvien.cori!following the “leveraged buyout revolution” of the 1980$. This link between the level and the "slope" of compensation has yet to beWhy Has CEO Pay Increased So Much
calibrated with the usual constant relative risk aversion utility function.- Higher incentives have certainly played a role in the rise of average exGọi ngay
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