Big Companies, Big Bosses

I’ve been meaning for the last couple of weeks to blog on the various interesting papers discussed at the NBER Summer Institute this year, which some regard as the Wimbledon of labour economics. Some I’d already written about, such as Leigh Linden and Jonah Rockoff’s paper on Megan’s Law. But one I hadn’t seen before was a pretty compelling explanation of the rise in CEO pay.

Why Has CEO Pay Increased So Much?
Xavier Gabaix & Augustin Landier
This paper develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO’s pay changes one for one with aggregate firm size, while changing much less with the size of his own firm. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. The sixfold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies during that period. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. The data broadly support the model. The size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries.

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