Explaining the Compensation of Superstar CEOs: The Case of Elon Musk *

Abstract

While agency theory has strongly influenced real-world compensation plans, most observed compensation plans are not explicit about their economic assumptions. In this study, we derive closed-form expressions to infer the cost of effort, the manager's surplus, and the contribution of effort to the firm based on the mapping between pay and performance described in real-world CEO contracts. When the agent is near risk-neutral, these primitives can be recovered from a linear regression of performance on pay. We apply the model to Musk's 2018 controversial incentive plan and show that Musk (i) did not have significant bargaining power, (ii) was primarily compensated for large opportunity costs, (iii) was expected to generate considerably less value than the firm's ex-post performance, and (iv) inducing effort would have been infeasible or prohibitively expensive without performance vesting options. The model offers a tractable framework to understand the assumptions underlying large, high-powered incentive plans for ``superstar" CEOs.

Keywords: CEO, compensation, incentives, agency, option C6, D8, M4