For years, many observers have characterized the annual pay packages awarded to the executives and chief executive officers (CEOs) of the nation's largest firms as excessive. According to one estimate, the total median CEO pay at the nation's 350 largest publicly owned firms grew from $2.7 million in 1995 to $6.8 million in 2005. The overall increase in CEO pay has outstripped inflation and the growth in non-managerial pay over the same period, fueling criticism of executive compensation packages. Among the quite vociferous critics of executive pay are public officials, academics, shareholders, and some Members of Congress. For example, William J. McDonough, chairman of the Public Company Accounting Oversight Board, has said that there is "... nothing in economic theory to justify the levels of executive compensation that are widely prevalent today." Warren Buffett has observed that "...it's difficult to overpay the truly extraordinary CEO of a giant enterprise. But this species is rare." Former Securities and Exchange Commission (SEC) Chairman Arthur Levitt, Jr. has written that "these huge paydays, I believe, undermine corporate governance and send a signal that boards are willing to spend shareholders' money lavishly..." In addition, a 2006 survey found that 90% of institutional investors, who are the largest owners of outstanding domestic corporate shares, said that executives at most companies are overpaid. There are also a number of current examples of congressional concerns over executive pay. For example, the version of H.R. 2 (the minimum wage bill) passed by the Senate on February 1, 2007, included several tax provisions, one of which applies to executive pay. Current tax rules permit individuals to defer taxes on income that is held in non-qualified deferred compensation plans. Under the Senate version of H.R. 2 , an individual could defer no more than $1,000,000 annually from taxable income by contributing to such a plan. The version passed by the House had no similar provision. Arguing for the cap, Chairman Max Baucus of the Senate Finance Committee, which unanimously passed the tax provisions that became part of the Senate version of H.R. 2 , observed: Rank-and-file workers generally have to pay taxes on their compensation when they earn it. The exception is deferred compensation provided through qualified retirement plans with statutory limits on contributions and benefits. A 401(k) is the best example. Management, on the other hand, has no limit on the amount that can be deferred to nonqualified arrangements—no limit... With respect to CEO pay, Chairman Barney Frank of the House Financial Services Committee said that: I do not think the boards of directors work as effective independent checks. They are not the fox guarding the hen house. They are the hens guarding the rooster. And I think the time has come to say we need the shareholders to do this.... In the 110 th Congress, Representative Frank has introduced the Shareholder Vote on Executive Compensation Act ( H.R. 1257 ), which was approved by the House on April 19, 2007. Soon afterwards, Senator Obama introduced an identically named companion bill, S. 1181 . The bills would require publicly held companies to hold annual non-binding shareholder votes on their executive compensation plans and any new "golden parachute" compensation offered to executives during mergers and acquisitions. Critics argue that excessive executive pay can be significantly traced to the fact that the members of corporate boards are not sufficiently independent of managerial influence. In this view, boards formulate executive pay packages that often allow executives to extract hefty compensation deals that bear little relationship to their contribution to the firms. In addition, if corporate executives are overpaid, other potentially significant concerns include the following: Issues over pay inequality and worker productivity. According to one estimate, between 1994 and 2005, the ratio of annual median CEO pay to median production worker pay nearly doubled, growing from 90 to 1 to 179 to 1. Indeed, for many workers, the perceived excessiveness of executive pay has become the most visible embodiment of growing pay inequality, contributing to a feeling that workers have not shared in the gains from economic growth. For example, adjusted for inflation, average worker pay rose 8% from 1995 to 2005; median CEO pay at the 350 largest firms rose about 150% over the same period. And while it is very difficult to quantify the impact of executive pay packages on worker morale and productivity, there are concerns that both could be affected detrimentally. For example, there have been several high profile stories of executives who have laid off employees at the same time their own compensation was rising. A potentially negative direct impact on shareholder returns. If executive compensation has been receiving a share of corporate resources that far exceeds the executives' contribution to the firm's value, shareholder returns may be compromised. Although not directly addressing the issue of whether increases in executive pay have been accompanied by commensurate increases in their value to the firms, one study compared the total pay given to the top five executives relative to corporate earnings at S&P 1500 firms between 1993-1995 and 2001-2003. It found that the ratio of executive pay to aggregate corporate earnings doubled between the two periods. A potential proxy for sub-par board performance in monitoring executives. When a corporate board is unable to get a handle on excessive CEO pay, it may be a sign of the board's failings in its central role of corporate governance. A purported link between excessive executive pay and the corporate scandals of recent years. Critics argue that a misalignment of incentives from executive pay helps explain the occurrence of scandals involving stock options backdating, accounting fraud, and earnings manipulation. But this "managerial power" perspective of how flawed corporate governance serves to inflate CEO pay is at odds with an alternative notion that the increase has largely been a function of natural market-driven changes in the demand and supply for CEOs. For example, during a 2006 interview with The Wall Street Journal , then Treasury Secretary John Snow observed that "in an aggregate sense... [CEO pay] reflects the marginal productivity of CEOs.... Until we can find a better way to compensate CEOs, I'm going to trust the marketplace." Like Secretary Snow, others argue that market forces are more likely than government to solve any problems that do exist with excessive pay. In his state of the economy address on January 31, 2007, President Bush said: Government should not decide the compensation for America's corporate executives, but the salaries and bonuses of CEOs should be based on their success at improving their companies and bringing value to their shareholders. America's corporate boardrooms must step up to their responsibilities. You need to pay attention to the executive compensation packages that you approve. You need to show the world that American businesses are a model of transparency and good corporate governance. Whether or not policy intervention is merited to tackle the issue of executive pay will depend on whether the managerial power or the market-based view of executive pay is the accurate one. Given congressional concerns with the potentially serious implications of excessive executive pay, this report examines critical and supportive evidence surrounding the premise that the executives are generally overpaid from an economic perspective. The report also provides a brief history of executive pay regulation and analyzes policy options. But first, the report looks more closely at the available data. Median CEO pay began its rapid rise in 1993. As seen in Figure 1 , which goes to 2005, it rose 35% in 2001 alone, which would later prove to be the high point. The current economic expansion has not been as favorable to CEOs. Contrary to popular belief, executive pay does not always rise—following the large decline in stock prices, median pay fell 13% from 2001 to 2002. Since then it has made up lost ground, and median pay in 2005 was nearly equal to its 2001 peak. The 1990s were not the first time that CEO pay had risen rapidly; it also rose by about one half from 1982 to 1987. As important as the trend in the level of CEO pay is the trend in the composition of CEO pay. Since 1995, median annual cash salary has risen relatively slowly, from $0.7 million in 1995 to about $1 million in 2006. But over the same period, median performance-based pay, which includes stock and stock option grants, grew 13% a year, from $1.3 million to $4.1 million. As will be discussed later, the role of stock and stock options in executive pay helps explain why it rose so quickly in the 1990s, and why it fell in 2002. The disparity between the pay given to U.S. executives relative to the compensation awarded to CEOs in other nations is often mentioned as evidence that American executives are overpaid. For example, controlling for various firm characteristics such as size, one study examined pay for CEOs in the United States and the United Kingdom (UK) in 2003. It found that CEO pay in the United States to be about 1.3 times that of CEOs in the UK and argued that a significant portion of the greater U.S. CEO pay could be attributed to the higher proportion of equity-based pay, such as stock options, in the United States, and the higher risk premiums associated with such pay. Research on Japanese executives found that after controlling for firm size, their pay constituted about a third of the pay of their U.S. counterparts in 2004. However, in Japan, the UK, and many other nations of the developed world, there are reports that CEO pay levels abroad have been slowly converging with the United States over time. High and rising executive pay could be a cause for policy concern on efficiency grounds or on equity grounds. Current pay levels would be economically inefficient if they resulted from a market failure that prevented pay levels from reflecting an equilibrium between supply and demand in the labor market for executives. If so, a policy response might be justified on the grounds that resources could be allocated in the economy more efficiently.