CEO pay, agency, and the theory of the firm
This dissertation deals with the relationship between executive compensation and corporate control. The chapters II and III deal specifically with the effect, on the compensation of a chief executive officers (CEO), of changes in the perceived threat of a hostile takeover of their firm. Chapter IV considers the general problem of the executive pay in theories of the control and behavior of firms, and the effect of market liberalization on income distribution within firms.
In Chapter II, a simple efficiency wage model of CEO pay is combined with a model of a firm constrained by a threat of hostile takeover. Three versions of the model are specified, corresponding to three different assumptions about who controls the pay-setting process (the shareholders, the board of directors, or the CEO). I then ask how the level of CEO pay changes with an exogenous change in the cost of a hostile takeover, and conclude that the sign of the change depends upon who controls the pay-setting process.
Chapter III is an econometric exploration of the models in chapter II. The probability of hostile takeover is modeled as a function of time, industry, and a firm's financial characteristics. Probit estimates of this probability are included as a variable in CEO wage equations for large US firms from 1979-1988. An increased threat of takeover is found to cause a small but statistically significant increase in CEO pay. This is consistent with the view that CEO pay is determined by the CEO, and inconsistent with the view that the CEO is the agent of either the shareholders or the board of directors.
Chapter IV begins with a critical appraisal of research on executive pay which has been based on the assumption that the locus of control of the firm can be inferred from the relationship between executive pay and various measures of a firm's performance. I show that these inferences are mostly wrong. Next, I show that recent developments in agency theory have undermined the conventional view that the governance structure of the firm can be interpreted as an optimal contract. Finally, I consider the large unexplained differences in the level of CEO pay, between industries and countries, and between time periods. I use a simple efficiency wage model to provide a consistent explanation of how various institutional differences, and differences in industry characteristics, cause differences in the level of CEO pay.