Out of Control Policy Blog

Maybe corporate fat cats deserve those salaries after all

    From 1980 to 2003, the average compensation of an American chief executive at a top 500 company rose by a factor of about six. The average compensation for the chief executives of these top companies reached roughly $11 million a year, including the value of options.
    ...

    Not surprisingly, many people think the American executives are overpaid. Their salaries are set by corporate boards, often filled with insiders or friends. Salaries for the top executive are far from transparent, especially when stock options and complex compensation plans are used. Nor is pay always linked to performance. Kenneth L. Lay received a salary and bonus of more than $8 million plus perks in 2000, less than a year before Enron's collapse.

    But in a new paper, "Why Has C.E.O. Pay Increased So Much?" (http://ssrn.com/abstract=901826), the economists Xavier Gabaix of the Massachusetts Institute of Technology and Augustin Landier of the Stern School of Business at New York University offer a contrarian view. They suggest that the higher salaries for chief executives can largely be explained by increases in the value of the stock market. Viewed as a whole, these salaries are a result of competitive pressures rather than the exploitation of shareholders.

    Their core argument is simple. If we look at recent history, compensation for executives has risen with the market capitalization of the largest companies. For instance, from 1980 to 2003, the average value of the top 500 companies rose by a factor of six. Two commonly used indexes of chief executive compensation show close to a proportional sixfold matching increase (the correlation coefficients are 0.93 and 0.97, respectively; 1.0 would be a perfect match).

More from Tyler Cowen here.

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