The average pay of a chief executive officer (CEO) in a top U.S. firm has increased six-fold in the last three decades. Simultaneously, the composition of pay has moved away from salary-based and increasingly toward performance-based compensation in the form of stock grants and stock option grants. This has strengthened the link between CEO pay and firm performance. Anecdotal evidence on the recent corporate fraud scandals suggests that some incentive problems remain unsolved. However, the academic literature reviewed in this article concludes that changes in market characteristics and the economic environment can partly explain the increase in pay and sensitivity of pay. A market-driven improvement in shareholders’ power, together with recent regulatory efforts of corporate governance practices, seems to have produced a healthier corporate sector in which high salaries are not necessarily a sign of entrenchment and inappropriate incentives for executives.
Our Research Focus: Labor Markets
Amanda L. Kramer
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