NCPA - National Center for Policy Analysis


May 23, 2006

The higher salaries for American chief executives can be largely explained by increases in the value of the stock market, say economists Xavier Gabaix and Augustin Landier.

This contrarian view suggests that the salaries are a result of competitive pressures rather than the exploitation of shareholders, say Gabaix and Landier:

  • History shows that compensation for executives has risen with the market capitalization of the largest companies; from 1980 to 2003, the average value of the top 500 companies rose by a factor of six.
  • Two commonly used indexes of chief executive compensation also show close to a proportional six-fold matching increase.
  • Chief executives' salaries in different sectors are higher when the capitalization of that sector is higher; a stronger sector means more bidders for a chief executive of a particular kind.
  • Chief executives in large industries, therefore, receive more, even after adjusting for the size of their current companies; business services, computers and banking turn up as exceptions for this comparison because their top executives are overpaid relative to what market capitalization alone would imply.

International comparisons are more difficult, but the preliminary results suggest that the total value of the companies in the sector helps predict how chief executives' salaries vary from country to country, say Gabaix and Landier.

However, critics argue that pay remains insensitive to performance, that high executive pay is correlated with bad corporate governance and that chief executives take great care to hide their true compensation. Nevertheless, the rate of productivity growth in the United States has been the envy of the world. Chief executives must be doing something right, says Gabaix and Landier.

Source: Tyler Cowen, "A Contrarian Look at Whether U.S. Chief Executives Are Overpaid," New York Times, May 18, 2006; based upon: Xavier Gabaix and Augustin Landier, "Why Has C.E.O. Pay Increased So Much?" MIT Department of Economics Working Paper No. 06-13, May 8, 2006.

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