Growth Through Rigidity: An Explanation for the Rise in CEO Pay

53 Pages Posted: 8 Feb 2016 Last revised: 19 Jul 2018

See all articles by Kelly Shue

Kelly Shue

Yale School of Management; National Bureau of Economic Research (NBER)

Richard R. Townsend

University of California, San Diego (UCSD) - Rady School of Management

Date Written: February 2016

Abstract

The dramatic rise in CEO compensation during the 1990s and early 2000s is a longstanding puzzle. In this paper, we show that much of the rise can be explained by a tendency of firms to grant the same number of options each year. Number-rigidity implies that the grant-date value of option awards will grow with firm equity returns, which were very high on average during the tech boom. Further, other forms of CEO compensation did not adjust to offset the dramatic growth in the value of option pay. Number-rigidity in options can also explain the increased dispersion in pay, the difference in growth between the US and other countries, and the increased correlation between pay and firm-specific equity returns. We present evidence that number-rigidity arose from a lack of sophistication about option valuation that is akin to money illusion. We show that regulatory changes requiring transparent expensing of the grant-date value of options led to a decline in number-rigidity and helps explain why executive pay increased less with equity returns during the housing boom in the mid-2000s.

Suggested Citation

Shue, Kelly and Townsend, Richard R., Growth Through Rigidity: An Explanation for the Rise in CEO Pay (February 2016). NBER Working Paper No. w21975. Available at SSRN: https://ssrn.com/abstract=2729095

Kelly Shue (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Richard R. Townsend

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

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