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Research on the determinants of executive compensation has a very long tradition in a variety of academic fields. This chapter focuses on the key ideas that emerge from a review of this work, especially in the management literature. Executive pay is generally determined by economic factors, social factors, and political factors, each of which is examined in this chapter. Economic factors include size, performance, human capital, risk, and marginal product. Managerial discretion, discussed in Chapter 2, also plays a big role. Social factors tend to fall into three categories—institutional pressures, social comparison processes, and social capital—each of which suggests alternative predictors of executive compensation. Finally, political factors are very much about power. The chapter concludes with a short section on the compensation of general managers at a business-unit level.

The consequences of executive pay are complex and particularly rich in a theoretical and practical sense. This chapter examines one of the most fundamental questions in this regard: Does executive pay affect firm performance? The evidence is decidedly mixed, but raises key questions about pay as a motivator, and the different ways in which executive pay can influence strategic and organizational choices as well as firm performance. This chapter also considers the burgeoning literature on behavioral agency theory, which leads naturally to a comparison of the effects of different types of compensation, especially stock options. A significant part of this chapter is dedicated to an analysis of the determinants and consequences of pay differentials among top management teams, another area of great theoretical interest. Studying pay differentials (or pay dispersion), as well as the pattern of compensation in place among the CEO and other top managers, yields fascinating insights that have important consequences for teamwork, perceived fairness of pay, strategic decision making, and firm performance.

Both Sarbanes–Oxley and Dodd–Frank included new executive compensation regulations. A key question is whether these provisions addressed actual corporate governance failures or were simply a sop to populist outrage. In either case, one must also ask whether the new restrictions are likely to be effective. It is argued that the one-size-fits-all approach mandated by the Sarbanes–Oxley Act and the new self-regulatory organization listing standards is seriously flawed.

This chapter presents a fundamental component of every firm's internal control system, its compensation program. The basic paradigm espoused by the proponents of VBM is that what a firm measures and rewards will get done. Consequently, the compensation program must measure employees’ activities that contribute toward wealth creation and reward those efforts. In essence, the compensation plan should pay employees to think and act like owners. Both the level of compensation and its form and composition are discussed. Many observed problems and potential remedies are presented. One characteristic that firms must be aware of is the public's perception that executive compensation has become unacceptably excessive. A complete V_sBM program must consider the political implications of its behavior as these perceptions can and do effect a firm's reputation and ultimately its wealth-creating ability. One mechanism for addressing these perceptions is to consider fairness criteria when designing a compensation program.

The chapter provides a comprehensive transatlantic comparison of pay spanning six years and covering approximately 1,500 US firms and 900 firms from nine European countries with mandated pay disclosures. The authors show that US CEOs are paid significantly more than their foreign counterparts after controlling for company size, industry, and other characteristics. Moreover, US executives receive a greater share of their compensation in the form of stock options, restricted shares, and performance-based bonuses. In the end, the authors present the evolution in the UK, France, Germany, and Italy.

This chapter provides two practical applications of the legal theory of the firm elucidated in the book. One controversial issue addressed is executive compensation in corporations, which many observers believe has become disproportionate in some countries and within some firms. The chapter shows how some influential economic theories adopted simplistic “principal–-agent” prescriptions which contributed to imbalance and injustice in contemporary compensation practices (e.g. through the careless use of stock options). An institutional legal theory offers a corrective to this approach.A second controversial issue involves the political free-speech rights of corporations and other “business persons,” such as addressed in the controversial Citizens United case. The chapter argues that an institutional legal theory of the firm can deepen analysis and understanding on both sides of the debate. It also suggests possible directions for future compromise, such as mandatory disclosure requirements of the funding of political campaigns and other political activities of business firms.

This chapter analyzes the general level of executive compensation and explains the main components of executive pay packages. It focuses on two approaches that address why executive pay is so high and distributed across so many vehicles. The “optimal contracting” or “incentive alignment” approach stresses that executive compensation must be structured to provide executives the right incentives to manage the firm in a way that maximizes its value. The other approach, “managerial power hypothesis”, asserts that executives capture the pay-setting process and essentially write their own excessive paychecks.

This chapter discusses the ways in which economists and public policymakers conceive the system of executive compensation. It assesses the performance of firms in setting incentives for executives and how executives respond to those incentives. Incentives are powerful factors in stimulating human behavior and have become a tool self-consciously deployed in many aspects of contemporary life. However, problems develop when the incentives are too powerful or misdirected, leading to bad behavior or a variety of unfortunate results.

The global financial crisis is distinctive in its origins, its magnitude, and its consequences. This chapter examines the failures that led to the crisis and, in particular, the important role played by information and incentives problems. On the basis of this diagnosis, the author provides recommendations on how to reform financial regulation to prevent future crises. The crisis provides an excellent case study in the economics of information. Stiglitz illustrates how the models—those used explicitly by or implicit in the mind of both regulators and market participants—ignored the imperfections and asymmetries of information. Since incentives mattered, distorted incentives at both the individual and organizational level led to distorted behavior. These distorted incentives included executive compensation systems in banks and conflict of interest in rating agencies. Additional problems were caused by the repeal of Glass‐Steagall, moral hazard, the use of complexity to reduce competition and increase profit margins, as well as moral hazard problems created by securitization.

The chapter sketches the evolution of pay practices in the United States, focusing particular attention on policies enacted to regulate CEO pay, and the unintended (and usually counterproductive) consequences of those policies. The authors argue that many of the trends in compensation levels and practices can be traced directly to government responses to actual or perceived abuses in pay, often stemming from isolated events involving a single company or industry.

One of the key issues raised by Occupy Wall Street movement that began in 2011 pertains to the morality and the propriety of compensation levels of top executives in the recent past that were perceived to be unconscionably high and disproportionate to performance of companies. CEO compensation trends in India, while not universally extortionist, are still perceived to be out of tune with the general pay levels in the country and, arguably, to be unrelated to their companies’ performance. This study empirically explores the relationship between CEO compensation and the various attributes of a company such as size, performance, type of ownership, and board structure and processes. The data analysed pertains to the largest quoted companies that were included in the NSE 100 index set, over a six-year period between 2007 and 2012. The conclusions provide interesting insights of particular relevance not only to India but also to other countries with a predominance of concentrated share ownership and promoter control of companies.

Chapter 7 concludes with how journalism might rethink the nature of America’s “job killers” by considering excess executive compensation, private equity, hedge funds, and offshore corporate tax havens as job killers that stockpile wealth and kill the creation of sustainable jobs – the kind of jobs the “Fight for $15” and other movements have advocated. The chapter also features the story of the financial industry’s intentional sabotage of workers, the news media coverage of the 2012 shutdown of Hostess, and the 2018 teacher strikes.The chapter also identifies where journalism can improve its coverage, erase the red-lining of the working class, and make workers visible again.

The chapter describes how the financial crisis has created a public uproar over top-executive pay packages and has led to calls for reform of executive pay in Europe and in the United States. The authors argue that government should resist temptations to regulate pay schemes, since regulation always creates unintended and costly side effects. Improvements in executive compensation can only emanate from a stronger corporate governance, and not through government intervention (even when well intended).

This chapter summarizes the weight of evidence on incentive compensation and shows how it can be improved through the strengthening of corporate governance. It characterizes a system of beneficial incentives and suggests improvements that can occur within the general framework of corporate governance and regulation. Whether or not the desirable outcome can be achieved, executive pay will still be based on incentive compensation. No matter how refined and improved corporate governance and governmental regulation becomes, the system of executive compensation will still suffer from the plunders of unscrupulous CEOs for whom “too much is not enough”.

This chapter uses pay in the home construction industry during the recent housing boom and bust to illustrate the second of the two competing theories that economists use to understand executive compensation: the managerial power hypothesis. According to this theory, boards at some firms have such weak bargaining positions that the only constraint on executive pay is the prospect of shareholder outrage. The theory’s central prediction is that weak boards and strong CEOs combine to find ways to pay executives that reduce the threat of shareholder outrage. This chapter develops this prediction and demonstrates its ability to explain observed pay practices that have the effect of camouflaging high pay levels.