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http://ssrn.com/abstract=337661
 
 

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CEO Incentives and Firm Size


George P. Baker


HBS Negotiations, Organizations and Markets Unit; National Bureau of Economic Research (NBER)

Brian J. Hall


NOM Unit Head, Harvard Business School; National Bureau of Economic Research (NBER)


Journal of Labor Economics, Forthcoming

Abstract:     
What determines CEO incentives? A confusion exists among both academics and practitioners about how to measure the strength of CEO incentives, and how to reconcile the enormous differences in pay sensitivities between executives in large and small firms. We show that while one measure of CEO incentives (the dollar change in CEO wealth per dollar change in firm value) falls by a factor of ten between firms in the smallest and largest deciles in our sample, another measure of CEO incentives (the value of CEO equity stakes) increases by roughly the same magnitude. We resolve the confusion about which of these measures better reflects CEO incentives by developing and solving a model that allows CEO productivity to differ for firms of different sizes. The crucial parameter is shown to be the elasticity of CEO productivity with respect to firm size. Our empirical results suggest that CEO marginal products rise significantly, and overall CEO incentives are roughly constant or decline slightly with firm size. We thus confirm Rosen's (1992) conjecture that the actions of executives in larger firms have a "chain-letter like" effect on firm performance. We also show that the appropriate measure of incentives depends on the type of CEO activity being considered. For activities whose dollar impact is the same for large and small firms (such as the purchase of a corporate jet), the dollars-on-dollars measure is appropriate, and large firms suffer significant agency problems due to their weak incentives. For activities whose percentage impact is similar across firms of different sizes (such as a corporate reorganization), the equity stake measure is better, and the incentive problem faced by large firms is not as severe. Finally, using a multi-task model, we discuss the implications of our findings for the design of control systems.

Keywords: Stock Options, Corporate Governance, Incentives, Executive Compensation, CEO Compensation

JEL Classification: G30, J33, J44, L25, M12, M52

Accepted Paper Series


Not Available For Download

Date posted: November 13, 2002  

Suggested Citation

Baker, George P. and Hall, Brian J., CEO Incentives and Firm Size. Journal of Labor Economics, Forthcoming. Available at SSRN: http://ssrn.com/abstract=337661

Contact Information

George P. Baker (Contact Author)
HBS Negotiations, Organizations and Markets Unit ( email )
Soldiers Field
Boston, MA 02163
United States
617-495-6119 (Phone)
617-496-4191 (Fax)
HOME PAGE: http://www.people.hbs.edu/gbaker/index.html
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Brian Hall
NOM Unit Head, Harvard Business School ( email )
Soldiers Field
Boston, MA 02163
United States
617-495-5062 (Phone)
617-496-4191 (Fax)
HOME PAGE: http://www.people.hbs.edu/bhall/
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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