More Pieces of the CEO Compensation Puzzle

Abstract

No current issue in corporate governance is more hotly debated than the question, Why are American CEOs paid such high salaries? A recent and influential answer, dubbed the managerial power approach, has an appealing simplicity: CEOs so thoroughly control their firms' compensation-setting machinery that they simply pay themselves whatever they want, restrained only by the tenuous limits of their own avarice and the vague need to avoid public outrage. As an explanation for a complex process, however, the simplistic managerial power approach is so flawed as to be nearly useless. The single most intriguing feature of CEO compensation, for example, is its meteoric rise during the 1990s, the very period when CEO control over boards was declining and public outrage was increasing, yet the managerial power approach has no convincing explanation for the anomaly. This article argues that the managerial power approach's failure is rooted in several theoretical problems, including (1) its tacit assumption that we can tell how much CEOs ought to be paid; (2) its reliance on a model of arm's-length bargaining, instead of the relational bargaining model that modern contract theory suggests is usual in employment relationships, (3) its failure to distinguish between the bargaining power of the CEO and the CEO's control of the bargaining process, and (4) its failure to examine CEO compensation in the context of the drastic rise in compensation of those at the tops of many other fields, including baseball players. The article argues that a full explanation of the compensation process will necessarily have to take these factors into account. The managerial power approach is simple and it fits nicely with common ideas about the greed of corporate executives, but it is not a useful description of the CEO compensation process.

Keywords: CEO, salaries, compensation, Delware, Journal