Why Has CEO Pay Increased so Much?

39 Pages Posted: 16 May 2006  

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); New York University - Stern School of Business

Augustin Landier

Toulouse School of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: May 8, 2006

Abstract

This paper develops a simple competitive model of CEO pay. A large part of the rise in CEO compensation in the US economy is explained without assuming managerial entrenchment, mishandling of options, or theft. CEOs have observable managerial talent and are matched to assets in a competitive assignment model. Under very general assumptions, using results from extreme value theory, the model determines the level of CEO pay across firms over time, and the pay-sensitivity relations. The model predicts a cross-sectional constant-elasticity relation between pay and firm size. It also predicts that the level of CEO compensation should increase one for one with the average market capitalization of large firms in the economy. Therefore, the six-fold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies. The model can also be used to study other large changes at the top of the income distribution, and offers a benchmark for calibratable corporate finance. We find a minuscule dispersion of CEO talent, which nonetheless justifies large pay levels and differences. The empirical evidence is broadly supportive of our model. The size of large firms explains many of the patterns in CEO pay, in the time series, across industries and across countries.

Keywords: Executive compensation, wage distribution, pay performance sensitivity, extreme value, theory, superstars, calibratable corporate finance

JEL Classification: D2, D3, G34, J3

Suggested Citation

Gabaix, Xavier and Landier, Augustin, Why Has CEO Pay Increased so Much? (May 8, 2006). MIT Department of Economics Working Paper No. 06-13. Available at SSRN: https://ssrn.com/abstract=901826 or http://dx.doi.org/10.2139/ssrn.901826

Xavier Gabaix (Contact Author)

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Augustin Landier

Toulouse School of Economics ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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