Restricting CEO pay

Regulatory Compensation Limits and Business Performance Evidence from the National Football League

“…Using an LEN model he shows that sufficiently large tax rate differentials can lead to a suboptimal allocation of CEO talent as the individual who is most compatible with one firm could end up being hired by the other firm. Dittmann, Maug, and Zhang (2011) discuss several restrictions on executive pay and analyze three types of restrictions: restrictions on ex post realized pay in order to avoid large payouts to executives across a range of possible scenarios (esp. "golden parachutes", "golden handshakes"), restrictions on components of pay (fixed vs variable), and, finally, restrictions on the ex-ante value of pay ("maximum wage").…”

“…Firms are thus not able to hire the most compatible executives anymore leading to frictions in the market for managerial labor. Dittmann et al (2011) also estimate the average reduction in firm value when firms are forced to reduce the total CEO pay due to the maximum wage law at 0.07% per 20% pay reduction. Abudy, and Shust (2016) analyze the stock market's reaction to the introduction of a maximum wage law in Israel in 2016.…”

“…The main reason for the scarce empirical results can be seen in the rarity of such legal measures being actually adopted. Transposing the results of the theoretical literature to the introduction of a mandatory maximum compensation one is inclined to expect it to be negatively related to the probability of hiring the most compatible individual as executive (Krenn 2016) and subsequently the firm's performance (Dittmann et al 2011).…”

“…Building on the model of Dittmann et al (2011), the analysis of the relation between maximum pay regulations and firm performance, uses a standard Cobb-Douglas production function assuming that the firm's performance ! is influenced by the effort " and the level of talent # (i.e.…”

“…Both, the cost of effort and the cost of talent are assumed to have isoelastic supply functions (Dittmann et al 2011) that relate the costs (=compensation) to the level of effort and talent respectively (1 and 2 are elasticities):…”