Executive Pay, Talent and Firm Size: Why has CEO Pay Grown so Much?

57 Pages Posted: 17 Jun 2009 Last revised: 19 Jan 2010

See all articles by Jaeyoung Sung

Jaeyoung Sung

Ajou University

Peter L. Swan

University of New South Wales (UNSW Sydney; Financial Research Network (FIRN)


We exposit an integrated agency model of multi-period career concerns and labor market equilibrium with managerial reservation utility levels, and thus pay levels, determined endogenously for firms of different sizes. Based on observations from a long time-series of S&P 1500 companies, we estimate the stochastic production function describing the incremental wealth created by the manager as a function of “effort”, latent raw “talent”, idiosyncratic firm risk (asset volatility) and the opening value of assets employed. We show that CEO talent affects the marginal productivity of the firm at approximately twice the rate as effort. Since asset volatility is also more subject to scale effects than effort, risk per marginal product of effort is higher in larger firms. Due to the cost of compensating managers for risk, pay-performance sensitivity optimally declines with size. Furthermore, our talent estimates explain much of the increments to real CEO pay levels and income over recent decades as a response to increases in talent and as compensation for higher risk borne by executives, with firm size growth playing a negligible role. We also identify the most talented CEOs who earned enterprise returns 17 times higher than the CEOs of the largest firms.

Keywords: executive pay, firm size, career concern, CEO talent, principal-agent

JEL Classification: G34, J41, J44, L25

Suggested Citation

Sung, Jaeyoung and Swan, Peter Lawrence, Executive Pay, Talent and Firm Size: Why has CEO Pay Grown so Much?. UNSW Australian School of Business Research Paper No. 2009 FIN 01, Available at SSRN: https://ssrn.com/abstract=1420952 or http://dx.doi.org/10.2139/ssrn.1420952

Jaeyoung Sung

Ajou University ( email )

Woncheon-dong, Yeongtong-gu
Suwon-si, Gyeonggi-do
Korea, Republic of (South Korea)

Peter Lawrence Swan (Contact Author)

University of New South Wales (UNSW Sydney ( email )

School of Banking and Finance
UNSW Business School
Sydney NSW, NSW 2052
+61 2 9385 5871 (Phone)
+61 2 9385 6347 (Fax)

HOME PAGE: http://https://www.business.unsw.edu.au/our-people/peterswan

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane

HOME PAGE: http://www.firn.org.au

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