The Compensation of University Presidents: A Principal-Agent Theory and Empirical Evidence

Abstract

This paper proposes an agency model with moral hazard and adverse selection of the relationship between a university and its president, and constructs a unique dataset to examine the determinants of the compensation of university presidents. In our model, the outcome of interest to the university depends on the unobservable effort and ability of the president, along with a signal of the president’s fit for the position that is unobservable to researchers. We postulate four hypotheses on the basis of our analytical model. First, a president with favorable personality traits is more adept at leading a complex university, so her compensation is increasing in the university’s complexity (stature). Second, due to adverse selection, the president’s compensation is increasing in her ability. Third, for a president with a prior presidency, the stature and size of her past university has a positive effect on her present compensation, since those are signals of ability. Fourth, research-oriented universities offer greater compensation to high ability presidents, due to complementarity between research-related tasks and ability. We collect a sample drawn from 279 private universities spanning the period 2001-2006, yielding a total of 1,011 university-year observations. Using four measures of the university’s stature and five measures of the president’s ability, we find strong support for our first three hypotheses, and obtain mixed results for the fourth hypothesis.

Keywords: adverse selection, moral hazard, executive compensation

JEL Classification: M46