The Efficiency Premium in Executive Compensation

Abstract

We present a model linking corporate efficiency and executive pay, predicting that more
efficient firms offer higher compensation to attract top talent. Since these firms are
also larger, it provides a new perspective on the joint distribution of firm size and CEO
pay. Using stochastic frontier analysis, we compute efficiency scores for US public firms
and identify an efficiency premium of 2.8%. Despite the positive correlation between
efficiency and executive pay, less efficient firms offer compensation that appears high for
their CEO talent levels. We conclude that inefficiency is associated with overpayment,
whereas more efficient firms demonstrate better compensation management.

Keywords: Executive Compensation, Corporate Efficiency, Executive-Firm Matching, Stochastic Frontier, Efficiency Premium

JEL Classification: C33, D24, G34, J33, M12