Executive Compensation: A Modern Primer

70 Pages Posted: 4 May 2015

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)

Multiple version iconThere are 3 versions of this paper

Date Written: April 2015

Abstract

This article studies traditional and modern theories of executive compensation, bringing them together under a unifying framework. 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 optimal contracting theories find it difficult to explain the data, suggesting that compensation results from "rent extraction" by CEOs. In contrast, more modern 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.

Suggested Citation

Edmans, Alex and Gabaix, Xavier, Executive Compensation: A Modern Primer (April 2015). NBER Working Paper No. w21131. Available at SSRN: https://ssrn.com/abstract=2602114

Alex Edmans (Contact Author)

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

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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 ECARES ULB CP 114
B-1050 Brussels
Belgium

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