Why has CEO pay increased so much?
By: Xavier Gabaix [and] Augustin Landier
Contributors: Landier, Augustin; Massachusetts Institute of Technology. Dept. of Economics
Edition: Rev.
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 06-13, Revised; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 06-13.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2006
Place of publication: Cambridge, MA
Language: eng
Number of pages: 38
Other titles: Why has chief executive officer's pay increased so much?
Description: This paper develops a simple competitive model of CEO pay. A large part of the rise in CEO compensation in the US economy is explained without assuming managerial entrenchment, mishandling of options, or theft. CEOs have observable managerial talent and are matched to assets in a competitive assignment model. Under very general assumptions, using results from extreme value theory, the model determines the level of CEO pay across firms over time, and the pay-sensitivity relations. The model predicts a cross-sectional constant-elasticity relation between pay and firm size. It also predicts that the level of CEO compensation should increase one for one with the average market capitalization of large firms in the economy. Therefore, the six-fold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies. The model can also be used to study other large changes at the top of the income distribution, and offers a benchmark for calibratable corporate finance. We find a minuscule dispersion of CEO talent, which nonetheless justifies large pay levels and differences.

(cont.) The empirical evidence is broadly supportive of our model. The size of large firms explains many of the patterns in CEO pay, in the time series, across industries and across countries. Keywords: Executive compensation, wage distribution, pay performance sensitivity, extreme value, theory, superstars, calibratable corporate finance. JEL Classifications: D2, D3, G34, J3.
Notes: "January 26, 2006. -- Revised: May 8, 2006."

Includes bibliographical references (p. 30-35).

Abstract in HTML and working paper for download in PDF available via World Wide Web at the Social Science Research Network.