December 11, 2011
Compensation in America
In the United States we are taught from a very young age to work hard so you can play hard. However, some people work hard their whole life and yet don’t get to play hard. Top executives are paid large tremendous wages compared to their subordinates. The growth in executive pay over the past decade has increased the attention given to the subject of executive compensation. There is now a heated debate about the quality of the pay setting process in publicly traded companies and the compensation arrangements that it produces (Bebchuk and Fried (2003, 2004), Hall and Murphy (2003), Jensen, Murphy, and Wruck (2004)). Compensation has grown by far more than could be explained by such changes. The relation between pay and firm size and performance has changed, with pay at the end of the period being considerably higher for companies of a given size, performance and industry classification. The fraction of equity-based compensation has grown across the board—in large firms, mid-size firms and small firms as well as in both new economy and old economy firms. Cash compensation has grown somewhat more than could be explained by the changes in size, performance and industry mix. The changes in the economic significance of executive pay. We find that executive pay has been economically meaningful. The aggregate compensation paid by public firms to top-five executives added up to about $350 billion. This aggregate top-five compensation accounted for 6.6% of the aggregate earnings (net income) of these firms during the period under consideration. The aggregate compensation paid by public firms to their top-five executives was 9.8% of the aggregate earnings of these firms.
Compensation is measured by a different number of standards. We use compensation information from the standard ExecuComp database, which includes information about executive compensation in public U.S. companies from 1993 onwards .The dataset includes all the S&P 500, Mid-Cap 400 and Small-Cap 600 companies. Together, these firms (also known as the S&P 1500) constitute more than 80% of the total market capitalization of U.S. public firms.
Annual compensation the (grant-date) value of the compensation package in the year in which it was given. In particular, following a standard definition of the total grant-date value of annual compensation reported in the ExecuComp database, we define an executive’s total compensation in a given year as the sum of the executive’s salary, bonuses, long-term incentive plans, the grant-date value of restricted stock awards and the (grant-date) Black-Scholes value of granted options. It is worth noting that the ExecuComp database does not include information about the value of executives’ pension plans because firms are not required to place and disclose a dollar value for these plans. As a result, research on executive pay has largely ignored the value of such plans (and the annual increase in their value). There is evidence, however, that the value of pension plans commonly comprises a major component of executives’ compensation (Bebchuk and Jackson, 2005). Thus, like much of the literature, the annual compensation figures we use do not include a significant source of additional compensation for many executives. In the early 1990's, some observers viewed executive compensation as quite high (Crystal (1991)).
Since then, however, compensation levels have climbed considerably. The mean compensation levels of the CEO and of the top-five executives during. Among S&P 500 firms, average CEO compensation climbed from $3.7 million in 1993 to$9.1 million in 2003 (an increase of 146%), and average compensation to top-five executives increased from $9.5 million in 1993 to $21.4 million in 2003 (an increase of 125%). We observe similar upward trends in both CEO pay and top-five executive pay among Mid-Cap firms and Small-Cap firms. The magnitude...
References: Bebchuk, Lucian A., and Jesse M. Fried. 2003. “Executive Compensation as an Agency
Problem.” Journal of Economic Perspectives 17: 71–92.
Bebchuk, Lucian A., and Jesse M. Fried. Pay without Performance: The Unfulfilled Promise of Executive Compensation, Harvard University Press, 2004.
Bebchuk, Lucian and Robert Jackson (2005), “Putting Executive Pensions on the Radar Screen,” Discussion Paper Number 507, John M. Olin Center for Law, Economics and Business,
Crystal, Graef S. 1991. In Search of Excess: The Overcompensation of American Executives. New York: W. W. Norton.
Hubbard, Glenn. 2005. “Pay without performance: a market equilibrium critique”, Journal of Corporation Law,
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