Is CEO Pay Really Inefficient? A Survey of New Optimal Contracting Theories
London Business School - Institute of Finance and Accounting; University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)
New York University - Stern School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
June 29, 2011
Europen Financial Management, Vol. 15, No. 3, pp. 486-496, June 2009
Bebchuk and Fried (2004) argue that executive compensation is set by CEOs themselves rather than boards on behalf of shareholders, since many features of observed pay packages may appear inconsistent with standard optimal contracting theories. However, it may be that simple models do not capture several complexities of real-life settings. This article surveys recent theories that extend traditional frameworks to incorporate these dimensions, and show that the above features can be fully consistent with efficiency. For example, optimal contracting theories can explain the recent rapid increase in pay, the low level of incentives and their negative scaling with firm size, pay-for-luck, the widespread use of options (as opposed to stock), severance pay and debt compensation, and the insensitivity of incentives to risk.
Number of Pages in PDF File: 13
Keywords: Executive compensation, pay-performance sensitivity, rent extraction, optimal contracting
JEL Classification: D2, D3, G34, J3
Date posted: September 24, 2008 ; Last revised: December 7, 2011
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