Restricting CEO Pay
46 Pages Posted: 22 Aug 2010 Last revised: 25 Jun 2011
Date Written: February 23, 2011
We analyze several proposals to restrict CEO compensation and calibrate two models of executive compensation that describe how firms would react to different types of restrictions. We find that many restrictions would have unintended consequences. Restrictions on total realized (ex-post) payouts lead to higher average compensation, higher rewards for mediocre performance, lower risk-taking incentives, and the fact that some CEOs would be better off with a restriction than without it. Restrictions on total ex-ante pay lead to a reduction in the firm's demand for CEO talent and effort. Restrictions on particular pay components, and especially on cash payouts, can be easily circumvented. While restrictions on option pay lead to lower risk-taking incentives, restrictions on incentive pay (stock and options) result in higher risk-taking incentives.
Keywords: Executive compensation, caps on pay, loss aversion
JEL Classification: G30, M52
Suggested Citation: Suggested Citation