Executive Compensation: A Modern Primer

Abstract

This article studies traditional and modern theories of executive compensation, bringing them together under a simple unifying framework accessible to the general-interest reader. We analyze assignment models of the level of pay, and static and dynamic moral hazard models of incentives, and compare their predictions to empirical …ndings. We make two broad points. First, traditional theories …nd it di¢ cult to explain the data, suggesting that compensation results from "rent extraction" by CEOs. However, more modern "shareholder value"theories that arguably better capture the CEO setting do deliver predictions consistent with observed practices, suggesting that these practices need not be ine¢ cient. Second, seemingly innocuous features of the modeling setup, often made for tractability or convenience, can lead to signi…cant di¤erences in the model's implications and conclusions on the e¢ ciency of observed practices. We close by highlighting apparent ine¢ ciencies in executive compensation and additional directions for future research.

Recovering Social Networks from Panel Data: Identification, Simulations and an Application

“…Our method is immediately applicable to other classic peer effects problems where large T panel data is readily available. For example, in finance, a long-standing question has been whether CEOs and other top executives are subject to relative performance evaluation, and if so, what is the comparison set of firms/CEOs used (Edmans and Gabaix, 2016). 37 Other fields such as macroeconomics, political economy and trade are all obvious areas in which long panel data sets exist for key outcomes, and social interactions across jurisdictions/countries etc.…”

Is corporate governance a first-order cause of the current malaise?

“…The common way to frame the debate over executive compensation is to oppose two models: managerial power (Bebchuk & Fried 2004), or optimal contracting (Kaplan 2012; see Edmans & Gabaix 2016). These models have a certain static quality that does not capture the dynamic by which compensation practices were formed and sustained, an evolutionary process on the model of a punctuated equilibrium, in which the factors of corporate governance, contagion, and path dependency have played a large role.…”

Call to Action: Intrinsic Motives and Material Interests

“…[8] provides a thorough critical overview of its applications in contracts, while Ref. [9] discusses its potential and limits in the domain of executive compensation.…”

“…8 Selecting action B generates an immediate consumption benefit, b 1 ∈ R ++ , as well as a delayed cost, b 2 ∈ R ++ . 9 The agent decides with the aim to maximise his utility, which is given by the present discounted value of his consumption payoff over periods 1 and 2, as well as a hedonic component, which is manipulated by the principal (more on this later). There is no hedonic component associated with action B.…”