Pay for Luck in CEO Compensation: Evidence of Illusion of Leadership?

Abstract:     
I apply the instrumental variables methodology of Bertrand and Mullainathan (2001) using data on the 100 highest paid CEOs from the Forbes magazine surveys covering the years 1970 to 2003. I use as instruments variables coming from the Initial Public Offerings (IPOs) - the number of IPOs and the average IPO underpricing in a given year.

I show that there was no pay for luck in the 80ies - a period of the US corporate history distinguished by active market for corporate control (large number of hostile takeovers and leveraged buyouts (LBOs)). It seems that when the incumbent management could be (and often were) challenged by shrewd outside investors, management and the board of directors were getting the compensation schemes right. On the other hand after the end of 80s when court decisions and legislation in the US brought the hostile takeover market to virtual halt (Jensen, Murphy and Wruck, 2004, page 23), economically large and statistically significant pay for luck emerges.

Working Paper Series