This paper provides an overview of the main theoretical elements and empirical underpinnings of a “managerial power ” approach to executive compensation. The managerial power approach recognizes that boards of publicly traded companies with dispersed ownership do not bargain at arms ’ length with managers, and that managers are able to influence their own pay arrangements. It thus views executive compensation not only as an instrument for addressing the agency problem between managers and shareholders, but also as part of the problem itself. We show that the managerial power approach can help explain many features of the executive compensation landscape, including ones that researchers have long viewed as puzzling. We explain that managerial influence produces efficiency costs because managers ’ seeking and camouflaging of rents produces

Using nationally representative workplace data for Britain we show how employers have changed their usage of contingent pay schemes over the last quarter century. We find workplaces are more likely to use collective forms of pay system than they did in the past, and they are more likely to use multiple schemes in combination. Factors associated with each type of pay scheme have varied substantially over time. The changing incidence of each form of contingent pay primarily reflects changes in the behaviour of workplaces rather than changes in the sectoral composition of the economy.

This paper provides a theory of broad-based option plans. Wage payments to managers and employees drive a wedge between total firm output and the fraction of output received by the firm’s owners. Consequently, owners ’ decisions whether, e.g., to continue the firm, shut it down, or sell it to another firm, are biased. Broad-based option pay minimizes this inefficiency. By minimizing the firm’s total wage payments in marginally profitable states, broad-based option pay minimizes the gap between total firm output and the owners ’ share of it in precisely those states where the bias is greatest. Moreover, option pay remains uniquely optimal if decisions are made by managers instead of owners, suggesting that options are robust optimal contracts in the sense that their optimality does not depend on who has decision-relevant information.

Corporate Governance and Equilar Inc. for providing a portion of the data used in this paper,

Innovation in the U.S. economy is about employing and rewarding highly talented workers to produce new products. Using unique longitudinal matched employer-employee data, this paper makes a key connection between talent and firms in markets with risky product innovations. We show that software firms that operate in product markets with highly skewed returns to innovation, or high variance payoffs, are more likely to attract and pay for star workers. Thus, firms in high variance product markets pay more up-front—in starting salaries— to attract and motivate star employees, because if these star workers produce home-run innovations, the firm’s winnings will be huge. However, we also find these same firms pay highly for loyalty: star workers that stay with a firm have much higher earnings in firms with high variance product market payoffs. The large effects on earnings are robust to the inclusion of a wide range of controls for both workers and firm characteristics. One key control is that we also show that in firms that have actually hit home runs, with high revenues, the rewards for star talent are even greater. We also find that the dispersion of earnings is higher within firms with high variance product payoffs.

paper represents a major extension of a section in Chapter 2 of my Ph.D. dissertation submitted to the University of California at Berkeley, where a two-asset equilibrium was developed. I am very grateful to Navneet Arora

Preliminary draft: Please do quote or circulate without permission

This paper investigates whether observed executive compensation contracts are designed to provide risk-taking incentives in addition to effort incentives. We develop a stylized principalagent model, calibrate it individually to the data of 737 U.S. CEOs, and show that it can explain observed compensation practice surprisingly well. In particular, it justifies large option holdings and high base salaries. Our analysis also suggests that options should be issued in the money. If tax effects are taken into account, the model is consistent with the almost uniform use of at-themoney stock options. We conclude that the provision of risk-taking incentives is a major objective in executive compensation practice.

This paper examines whether CEOs are fired after bad firm performance caused by factors beyond their control. Standard economic theory predicts that corporate boards filter out exogenous industry and market shocks to firm performance when deciding on CEO retention. Using a new hand-collected sample of 1,590 CEO turnovers from 1993 to 2001, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry and bad market performance. A decline in the industry component of firm performance from its 75 th to its 25 th percentile increases the probability of a forced CEO turnover by approximately 50 percent. This finding is robust to controls for firm-specific performance. The result is at odds with the prior empirical literature which showed that corporate boards filter exogenous shocks from CEO dismissal decisions in samples from the 1970s and 1980s. Our findings suggest that the standard CEO turnover model is too simple to capture the empirical relation between performance and forced CEO turnovers, and we evaluate several extensions to the standard model.

Abstract not found