Is it Ability or Size Alone Which Explains High Executive Pay in Large Firms? New Evidence on the 'Cloning' Hypothesis

Abstract

We present new direct empirical evidence in support of Rosen's (1982) 'cloning' hypothesis, explaining the overwhelming firm size-executive pay effect in terms of a predicted greater superiority in managerial talent the larger is the firm. We show that executives from better performing firms are more likely to join larger firms. In addition, utilizing 2SLS analysis the performance of the previous employer firm is a significant factor explaining the size of the firm the executive has joined. Remarkably, the prior performance of the firm which previously employed the executive is a more significant determinant of the executive's pay with the current employer than is current firm performance.

Keywords: executive pay, firm size, managerial ability, firm performance, cloning hypothesis

JEL Classification: J3, G3