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Is CEO Pay Really Inefficient? A Survey of New Optimal Contracting Theories

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  • Alex Edmans
  • Xavier Gabaix

Abstract

Bebchuk and Fried (2004) argue that executive compensation is set by CEOs themselves rather than boards on behalf of shareholders, since many features of observed pay packages may appear inconsistent with standard optimal contracting theories. However, it may be that simple models do not capture several complexities of real†life settings. This article surveys recent theories that extend traditional frameworks to incorporate these dimensions, and show that the above features can be fully consistent with efficiency. For example, optimal contracting theories can explain the recent rapid increase in pay, the low level of incentives and their negative scaling with firm size, pay†for†luck, the widespread use of options (as opposed to stock), severance pay and debt compensation, and the insensitivity of incentives to risk.

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  • Alex Edmans & Xavier Gabaix, 2009. "Is CEO Pay Really Inefficient? A Survey of New Optimal Contracting Theories," European Financial Management, European Financial Management Association, vol. 15(3), pages 486-496, June.
    • Handle: RePEc:bla:eufman:v:15:y:2009:i:3:p:486-496
    DOI: 10.1111/j.1468-036X.2009.00500.x
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