Why Has CEOs’ Pay Increased So Much?

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The figures that chief executive officers (CEOs) read at their payrolls are medially very attractive information. Why? They are huge! People process the information in many ways – someone is rude, someone envies, someone is emulated… Anyway, the same question occurs: Why has CEOS’ pay increased so much? You can find your answer here.

Average American CEO was paid about 331 times more than regular worker in 2013. In 1970 the ratio was approximately 50:1. Non-profit organization AFL-CIO have calculated that e.g. minimum wage employee from the biggest American food store chain Walmart would need to work 1,372 hours to achieve wage equal to 1 hour of CEO Michael Duke’s pay.

After 1970 CEOs’ wage and benefits were growing approximately 0.8 % per year in the US. CEOs’ wages also experienced bigger jump than the wages of other top executives. In 1970 the average CEO pay was $700,000 (in 2002 constant dollars). In 2000 it increased to over $2.2 million (Murphy, Zabojnik 2004).

What is the driver of the CEO pay’s increase? Is it a result of intensified importance of good managerial skills and higher scarcity of talented CEOs? Or is it a demonstration of a growing principal agent problem in large firms’ management? Opinions differ. Some economists explain the trend by increase in firm’s size (Gabaix and Landier, 2006). Generally CEO’s pay depends on the quality of CEO and his managerial talent. The compensation is usually connected to CEO’s age, education, tenure, and gender (e.g. Bertrand and Mullainathan, 2001, Tracy and Waldfogel, 1997). From the company point of view, CEOs from bigger companies usually receive higher remuneration (e.g. Garvey, Milbourn, 2006).

Another group of studies give alternative explanations for continuous positive trend in CEO salaries, which is not based on “hard” factors. For example Hayes and Schaefer (2008) discovered that large part of firms calculate CEOs reward based on other CEOs from companies in the same industry, which results in an upward spiral of wages, because companies aim to show that their CEO is paid above market average to demonstrate the strength of the firm.

Although experts struggle to find consensus about the CEO’s pay rise, several empirical facts related to stock market and CEOs are worth to notice as they serve as a good predictor of changes in company’s stock prices. For example companies with female leaders have systematically lower value (Wolfers, 2007, cited by Bertrand, 2010). Other interesting research was published by Pérez-Gonzales, who found that CEOs who inherit their functions from family members have deteriorating impact on company business and they are associated with the decrease in stock prices. The negative effect is even stronger for family CEOs who did not attend top universities (Wolfers, 2007, cited by Bertrand, 2010).

An article by Ludmila Hadincová

References

Bertrand, Marianne (2009): CEOs, The Annual Review of Economics, Vol. 1, pp. 121-150

Bertrand, Marianne; Mullainathan, Sendhil (2001): Are CEOs Rewarded for Luck? The Ones Without Principals Are, The Quarterly Journal of Economics, Vol. 116, No.3, pp. 901-932

Gabaix, Xavier; Landier, Augustin (2006): Why Has CEO Pay Increased So Much? The Quarterly Journal of Economics, MIT Press, Vol. 123, Issue 1, pp. 49-100

Garvey, Gerald T.; Milbourn, Todd T. (2006): Asymmetric Benchmarking in Compensation: Executives Are Rewarded for Good Luck but not Penalized for Bad, Journal of Financial Economics, Vol. 82, Issue 1, pp. 197 – 225

Murphy, Kevin J.; Zábojník, Jan (2004): CEO Pay and Appointments: A Market-Based Explanation for Recent Trends, American Economics Review, Vol. 94, No. 2, pp. 1-9

Schafer, S; Hayes R.M (2008): CEO Pay and the Lake Wobegon Effect, Journal of Financial Economics, [Available online]: http://www.law.harvard.edu/conferences/sloan/hayesschaefer09.pdf, [2/2/2015], pp. 1-25

Tracy, Joseph; Waldfogel, Joel (1997): The Best Business Schools: A Market Based Approach, Journal of Business, Vo. 70, No. 1, [Available online]: http://www.nber.org/papers/w4609.pdf, [14/12/2014], pp. 1-31

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