Executive Compensation: A Modern Primer

79 Pages Posted: 13 Mar 2015 Last revised: 10 Feb 2020

See all articles by Alex Edmans

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

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Date Written: June 26, 2017

Abstract

This article studies traditional and modern theories of executive compensation, bringing them together under a simple unifying framework accessible to the general-interest reader. We analyze assignment models of the level of pay, and static and dynamic moral hazard models of incentives, and compare their predictions to empirical findings. We make two broad points. First, traditional theories find it difficult to explain the data, suggesting that compensation results from “rent extraction” by CEOs. However, more modern “shareholder value” theories that arguably better capture the CEO setting do deliver predictions consistent with observed practices, suggesting that these practices need not be inefficient. Second, seemingly innocuous features of the modeling setup, often made for tractability or convenience, can lead to significant differences in the model’s implications and conclusions on the efficiency of observed practices. We close by highlighting apparent inefficiencies in executive compensation and additional directions for future research.

Keywords: Executive compensation, contract theory, principal-agent problem, rent extraction, optimal contracting

JEL Classification: D86, G34

Suggested Citation

Edmans, Alex and Gabaix, Xavier, Executive Compensation: A Modern Primer (June 26, 2017). Journal of Economic Literature 54(4), 1232-1287; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 450/2015 . Available at SSRN: https://ssrn.com/abstract=2576707 or http://dx.doi.org/10.2139/ssrn.2576707

Alex Edmans (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
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London NW1 4SA
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European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Xavier Gabaix

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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