Rose, Nancy L., NBER Reporter
The compensation of top corporate executives in the United States has attracted considerable attention over the last few years. Part of this is undoubtedly because of the high and rising pay levels reported for CEOs of the largest U.S. corporations. CEO salary and bonus at these firms has risen by more than 3 percent annually in real terms over the past two decades, to a median of almost $890,000, according to the Forbes survey of 1993 CEO compensation. The explosion of stock options and stock awards for CEOs, combined with overall increases in the stock market during this period, has meant even greater increases in real total compensation (more than 6 percent per year), and led to enormous variation in executive compensation across CEOs and over time. In the Forbes 1993 compensation survey, total compensation rose as high as $203 million for Michael Eisner of Walt Disney Corporation, with an overall median of $1.4 million. Although these substantial increases in compensation are not unique to CEOs - they echo similar trends across a broad range of professional occupations during the 1980s(1) - they have generated substantial media attention and political debate.
Much of this debate has focused on the equity implications of high CEO pay levels, particularly as a contributing factor to the overall increase in income inequality over the past decade. There is also a concern in some circles that high pay levels may reflect CEOs benefiting at shareholder expense, a result of inadequate oversight by corporate boards of directors. The political pressures created by this debate have given rise to a number of policy responses. In 1992 the Securities and Exchange Commission substantially revised its disclosure rules for reporting executive compensation on annual proxy statements. It now requires more detailed information on compensation components, options awards, and shareholder returns relative to other finns in the market or a defined "peer group." After calls for a cap on total CEO compensation, Congress passed legislation effective January 1, 1994 that eliminates the corporate tax deductibility of CEO compensation in excess of $1 million unless it is based on objective measures of firm performance. The Financial Accounting Standards Board (FASB) also reviewed the use of stock options in compensation. However, its original proposal to require the value of stock options to be deducted from corporate income when awarded ran into such heated opposition that the FASB's final ruling simply modified the reporting requirements for options.
While it is difficult to determine whether U.S. CEOs are paid "too much," many of the issues involved in the policy debate over executive compensation have been the subject of long-standing academic interest and investigation. Although some of the early studies of managerial compensation and incentives were conducted by industrial organization economists, most of the recent work falls within labor economics, corporate finance, organizational theory, and managerial accounting. Sherwin Rosen provides an excellent overview of the results of these analyses, which investigate the structure and determinants of executive compensation, the organization of managerial labor markets, and the effectiveness of corporate governance in monitoring and controlling managerial behavior.(2)
Two NBER colleagues, Paul L. Joskow of MIT and Andrea Shepard of Stanford University, and I recently have applied an industrial organization perspective to the analysis of executive compensation. We focused on three broad questions: First, what is the role of regulatory and political pressure in constraining executive pay? Second, what is the relationship between firm diversification and CEO compensation, and what are its implications for models of corporate governance and the market for CEOs? Third, what do more complex empirical models of incentive pay for CEOs suggest about the overall sensitivity and dynamic responses of executive pay to firm financial performance? …