Executive compensation in the USA

Abstract

There are few issues that have recently so fueled the ire of the masses as the perception that executive compensation has inflated out of control, especially in light of the recent economic crisis. A number of politicians have latched on to this populist theme and suggested political solutions. This paper addresses the issue in three parts. A critical first step is to attempt to place “excessive” compensation in a proper perspective, dispassionately evaluate if it indeed exists, and if so, has the situation been exacerbated in the last decade. Secondly, can the economic rewards granted to executive managers be linked to, and thus possibly be justified by the economic performance of their respective firms? Does human capital theory still apply to high-level executives allowing them to become rarified stars such as their counterparts in the entertainment and sports industries, or does a managerial theory incorporating entrenchment better explain recent payout trends? A review of previous academic work is presented, and the various opinions are discussed. Third, a quantitative analysis comprising the CEO payouts of the 30 companies comprising the DOW index is performed in order to evaluate relationships between CEO pay and performance based on annual changes in Market Value Added during the last decade. The conclusions are that agency theory remains valid for explaining trends in executive compensation, but suggest that entrenched mechanisms explained by managerial theory tend to dominate over economic justifications.