Are American CEOs overpaid, and, if so, what if anything should be done about it?

Duke Law Journal

Volumn 58, Issue 6, 2009, Pages 1013-1047

  Posner, Richard A ^a  

^a UNIVERSITY OF CHICAGO LAW SCHOOL   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 68049100114     PISSN: 00127086     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (94)

1. See Richard A. Posner, A Failure of Capitalism: The Crisis of '08 and The Descent Into Depression (forthcoming).
2. See, e.g., Joann S. Lublin & Scott Thurm, Money Rules: Behind Soaring Executive Pay, Decades of Failed Restraints, Wall St. J., Oct. 12, 2006, at A1; Aaron Lucchetti & Joann S. Lublin, Grasso Is Ordered to Repay Millions in Compensation, Wall St. J., Oct. 20, 2006, at A1; Gretchen Morgenson, Corporate America's Pay Pal, N.Y. Times, Oct. 15, 2006, § 3 (Business), at 1; Floyd Norris, Rethinking Risk's Role in Bosses' Pay, N.Y. Times, Oct. 12, 2007, at C1; Eduardo Porter, More Than Ever, It Pays to Be the Top Executive, N.Y. Times, May 25, 2007, at A1; Louis Uchitelle, Revising a Boardroom Legacy: An Early Advocate of Paying Chiefs Well Now Wants Them to Prove They Earned It, N.Y. Times, Sept. 28, 2007, at C1.
3. See, e.g., Lucian A. Bebchuk & Jesse M. Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation 1-12 (2004). Michael Weisbach agrees that Bebchuk and Fried have presented "fairly persuasive" evidence that corporate executives "control their own boards and. .. maximize their own compensation subject to an 'outrage constraint,'" though he disagrees with their proposals for reform. Michael S. Weisbach, Optimal Executive Compensation Versus Managerial Power: A Review of Lucian Bebchuk and Jesse Fried's Pay Without Performance: The Unfulfilled Promise of Executive Compensation, 45 J. Econ. Literature 419, 419, 423-26 (2007).
4. Congress, as part of the stimulus bill signed into law on February 16, 2009, has imposed even more stringent caps on the compensation of executives of recipients of bailout money. I do not discuss these.
5. On the costs and benefits of multidivisional corporate structure, see Henry Ogden Armour & David J. Teece, Organizational Structure and Economic Performance: A Test of the Multidivisional Hypothesis, 9 Bell J. Econ. 106, 106-08 (1978).
6. See F.A. Hayek, The Use of Knowledge in Society, 35 Am. Econ. Rev. 519 passim (1945); F.A. von Hayek, Economics and Knowledge, 4 Economica (n.s.) 33, 47-53 (1937).
7. On the difficulties of intrafirm knowledge transfers, see Gabriel Szulanski, Exploring Internal Stickiness: Impediments to the Transfer of Best Practice Within the Firm, 17 Strategic Mgmt. J. (Special Issue) 27, 27-32 (1996).
8. John Bishop, The Recognition and Reward of Employee Performance, 5 J. Lab. Econ. S36, S37-S41 (1987); see also Harley Frazis & Mark A. Loewenstein, Wage Compression and the Division of Returns to Productivity Growth: Evidence from EOPP 3 (U.S. Bureau of Labor Statistics, Working Paper No. 398, 2006), available at http://www.bls.gov/osmr/abstract/ec/ec060100.htm ("[O]nly 32 percent of differences in starting productivity are reflected in differences in starting wages, even after accounting for differences in productivity growth.").
9. See Robert Gibbons & Michael Waldman, Enriching a Theory of Wage and Promotion Dynamics Inside Firms, 24 J. Lab. Econ. 59, 93 (2006).
10. Robert Gibbons & Kevin J. Murphy, Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence, 100 J. Pol. Econ. 468, 486-95 (1992).
11. See Marianne Bertrand & Antoinette Schoar, Managing with Style: The Effect of Managers on Firm Policies, 118 Q.J. Econ. 1169, 1170-71 (2003).
12. See Yair Listokin, Management Always Wins the Close Ones 18-27 (Yale Law & Econ. Paper, Research Paper No. 348, 2007), available at http://ssrn.com/abstract=980695.
13. See, e.g., Harvard Business Review On Compensation (Harvard Business Review ed., 2001); Michael C. Jensen & Kevin J. Murphy, Remuneration: Where We've Been, How We Got to Here, What Are the Problems, and How to Fix Them ii, 19-22 (Harvard Bus. Sch. Negotiation, Orgs. & Mkts. Research Paper Series, Research Paper No. 04-28, 2004), available at http://ssrn.com/abstract=561305.
14. I have discussed these in my work on the reform of our national security intelligence services. See, e.g., Richard A. Posner, Preventing Surprise Attacks: Intelligence Reform In The Wake OF 9/11, at 137-38 (2005).
15. See supra pp. 986-87.
16. Towers Perrin, Worldwide Total Remuneration 2003-2004, at 20 (2004).
17. Randall S. Thomas, Explaining the International CEO Pay Gap: Board Capture or Market Driven?, 57 Vand. L. Rev. 1171, 1183 (2004).
18. Towers Perrin, Worldwide Total Remuneration 2005-2006, at 24 (2006)
19. Towers Perrin, supra note 16, at 24.
20. see also Trevor Buck, Azura Shahrim & Stefan Winter, Executive Stock Options in Germany: The Diffusion or Translation of US-Style Corporate Governance?, 8 J. Mgmt. & Governance 173, 174 (2004) (comparing the relative importance of base salary in CEO total compensation in the United States (27 percent) with the United Kingdom (43 percent) and Germany (52 percent))
21. Minoru Nakazato, J. Mark Ramseyer & Eric B. Rasmusen, Executive Compensation in Japan: Estimating Levels and Determinants from Tax Records 9, 14 (Harvard Law Sch., John M. Olin Ctr. for Law, Econ., & Bus., Discussion Paper No. 567, 2006), available at http://www.law.harvard.edu/programs/olin_center/papers/567_Ramseyer_etal.php
22. Martin J. Conyon, John E. Core & Wayne R. Guay, How High is US CEO Pay? A Comparison with UK CEO Pay 10-11 (June 2006) (unpublished manuscript), available at http://ssrn.com/abstract=907469 (reporting that British CEOs received 43 percent of their total compensation from normal salary, compared with 31 percent for U.S. CEOs). But see Alain Alcouffe & Christiane Alcouffe, Executive Compensation-Setting Practices in France, 33 Long Range Plan 527, 536 (2000) (reporting that French governments have "actively promoted" stock options "not only for executives but for all employees, with the underlying intention of aligning interests between the executives, employees and shareholders").
23. The source of the data for this table is Wharton Research Data Services, the home page of which explains: Executive Compensation database contains over 2500 companies, both active and inactive. The universe of firms cover the S&P 1500 plus companies that were once part of the 1500 plus companies removed from the index that are still trading, and some client requests. Data collection on the S&P 1500 began in 1994. However, there is data back to 1992 but it is not the entire S&P 1500. It is mostly for the S&P 500. Wharton Research Data Servs., Overview of Executive Compensation, http://wrds.wharton.upenn.edu/ (restricted access) (last visited Oct. 29, 2008) (on file with the Duke Law Journal).
24. Thomas, supra note 16, at 1202-09
25. In 2005, 35 percent of CEO turnover was involuntary in the United States, whereas the corresponding figure for Europe was 42 percent. Chuck Lucier, Paul Kocourek & Rolf Habbel, CEO Succession 2005: The Crest of the Wave, Strategy & BUS., Summer 2006, at 100, 109, available at http://www.strategy-business.com/media/file/sb43_06210.pdf.
26. Thomas, supra note 16, at 1186-89. Professor Thomas's excellent article mounts a powerful case that the differences in CEO pay between the United States and foreign countries are due to factors unrelated to overcompensation, including greater job mobility of U.S. executives and the fact that U.S. CEOs have more authority in their firms than their foreign counterparts do, as well as differences in risk. But Thomas does not attempt to measure the effect, singly or in the aggregate, of these factors. For the contrast between corporate ownership structures in German, Japan, and the United States, see Mark J. Roe, Some Differences in Corporate Structure in Germany, Japan, and the United States, 102 Yale L.J. 1927, 1936-41 (1993).
27. See, e.g., Bebchuk & Fried, supra note 3, at 33. Professors Bebchuk and Fried note that "in 2002, 41 percent of the directors on compensation committees were active executives, with about half of them active CEOs. Furthermore, another 26 percent of the members of compensation committees were. .. retirees [who] were for the most part former executives."
28. See id.
29. See David Koeppel, Fudging the Facts on a Résumé Is Common, and Also a Big Risk, N.Y. Times, Apr. 23, 2006, § 10, at 1; Ted O'Callahan, Study: Almost Half of Résumés Are Bogus, Inc.Com, Feb. 28, 2006, http://www.inc.com/news/articles/200602/resume.html.
30. Thomas Donaldson, Corporations And Morality 123 (1982).
31. See Sanjai Bhagat & Bernard Black, The Non-Correlation Between Board Independence and Long-Term Firm Performance, 27 J. Corp. L. 231, 263 (2002).
32. See, e.g., Ivan E. Brick, Oded Palmon & John K. Wald, CEO Compensation, Director Compensation, and Firm Performance: Evidence of Cronyism?, 12 J. Corp. FIN. 403, 421 (2006).
33. See Bebchuk & Fried, supra note 3, at 39; Gretchen Morgenson, Peer Pressure: Inflating Executive Pay, N.Y. Times, Nov. 26, 2006, § 3 (Business), at 1.
34. See Joann S. Lublin, Theory and Practice: Conflict Concerns Benefit Independent Pay Advisers, Wall St. J., Dec. 10, 2007, at B3; Gretchen Morgenson, House Panel Finds Conflicts in Executive Pay Consulting, N. Y. Times, Dec. 6, 2007, at C1.
35. Joann S. Lublin, Seeking New CEO, Some Boards Skip the Stars; Directors Enter Negotiations with Limits on Pay, Perks; On Tap: Backup Candidates, Wall ST. J., May 21, 2007, at B1.
36. Joann S. Lublin, Sharper Image Tries to Refocus with New CEO, Wall St. J., Mar. 26, 2007, at A12; Ruthie Ackerman, Sharper Image Files for Bankruptcy, Forbes.COM, Feb. 20, 2008, http://www.forbes.com/markets/2008/02/20/sharperimage-lillianvernon-retail-markets-equity-cx-ra-0220markets36.html; Robert Conway of Conway, Del Genio, Gries & Co., LLC Named Chief Executive Officer Replacing Steven Lightman, Jerry W. Levin to Remain Chairman, Reuters, Feb. 14, 2008, http://www.reuters.com/article/pressRelease/idUS155943+14-Feb2008+BW20080214; Yahoo! Finance, Sharper Image Corp. Historical Prices, http://finance.yahoo.com/q/hp?s=SHRPQ.PK&a=02&b=26&c=2007&d=01&e=14&f=2008&g=m (last visited Oct. 28, 2008).
37. See John E. Core, Wayne R. Guay & David F. Larcker, Executive Equity Compensation and Incentives: A Survey, Economic Policy Review, Fed. Res. Bank N.Y. Econ. Pol'Y Rev., Apr. 2003, at 27, 35; Brian J. Hall & Kevin J. Murphy, The Trouble with Stock Options, J. Econ. Persp., Summer 2003, at 49, 59, 58-61.
38. See Sharon Hannes, Gatekeeper Incentive Compensation 13-21 & nn.44-78 (Northwestern Law & Econ., Research Paper No. 08-19, 2008), available at http://ssrn.com/abstract=1263563.
39. Core et al., supra note 32, at 38.
40. See Wm. Gerard Sanders & Donald C. Hambrick, Swinging for the Fences: The Effects of CEO Stock Options on Company Risk Taking and Performance, 50 Acad. Mgmt. J. 1055, 1063 (2007).
41. Share-Based Payment, Statement of Fin Accounting Standards No. 123, § A240 (i) (Fin. Accounting Standards Bd. 2004), available at http://www.fasb.org/pdf/fas123r.pdf.
42. See, e.g., Randall A. Heron & Erik Lie, Does Backdating Explain the Stock Price Pattern Around Executive Stock Option Grants?, 83 J. Fin. Econ. 271, 294 (2007)
43. Erik Lie, On the Timing of CEO Stock Option Awards, 51 Mgmt. SCI. 802, 803 (2005)
44. Mark Maremont & Charles Forelle, Open Spigot: Bosses' Pay: How Stock Options Became Part of the Problem-Once Seen as a Reform, They Grew into Font of Riches and System to be Gamed-Reload, Reprice, Backdate, Wall St. J., Dec. 27, 2006, at A1
45. Lucian Bebchuk, Yaniv Grinstein & Urs Peyer, Lucky CEOs 1 & n.1 (Harvard Law Sch., John M. Olin Ctr. for Law, Econ., & Bus., Discussion Paper No. 566, 2006), available at http://ssrn.com/abstract=945392.
46. See Rajesh K. Aggarwal & Andrew A. Samwick, The Other Side of the Trade-Off: The Impact of Risk on Executive Compensation, 107 J. Pol. Econ. 65, 76-92, 103-04 (1999).
47. Canice Prendergast, The Tenuous Trade-Off Between Risk and Incentives, 110 J. Pol. Econ. 1071, 1077 tbl.1 (2002).
48. See infra pp. 1009-11.
49. See infra Part II.D.
50. See Alexander Dyck & Luigi Zingales, The Corporate Governance Role of the Media 30-31 (Nat'l Bureau of Econ. Research, Working Paper No. 9309, 2002), available at http://www.nber.org/papers/w9309; see also, e.g., Gretchen Morgenson, Executive Pay Becomes Political, N.Y. Times, Nov. 5, 2006, § 3 (Business), at 1.
51. See Lucian Arye Bebchuk & Jesse M. Fried, Executive Compensation as an Agency Problem, J. Econ. PERSP., Summer 2003, at 71, 79-81.
52. See infra note 64 and accompanying text
53. See Jeffrey N. Gordon, Executive Compensation: If There's a Problem, What's the Remedy? The Case for "Compensation Discussion and Analysis," 30 J. Corp. L. 675, 679 (2005).
54. See Thomas, supra note 16, at 1206
55. Towers Perrin, supra note 17, at 24
56. Nakazato et al., supra note 17, at 31.
57. Conyon et al., supra note 17, at 13.
58. See Xavier Gabaix & Augustin Landier, Why Has CEO Pay Increased So Much? 1 (MIT Dep't of Econ., Working Paper No. 06-13, 2006), available at http://ssrn.com/abstract=901826 ("[T]he six-fold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies.")
59. see also Steven N. Kaplan & Joshua Rauh, Wall Street and Main Street: What Contributes to the Rise in the Highest Incomes? 41 (Ctr. for Research in Sec. Prices, Working Paper No. 615, 2007), available at http://ssrn.com/abstract=931280 ("[T]he total amount of capital per employee at the top 50 firms in the securities industry. .. increased by almost nine times in real terms from 1987 to 2004."). The idea is not entirely new. See R. Glenn Hubbard, Pay Without Performance: A Market Equilibrium Critique, 30 J. Corp. L. 717, 718-19 (2005).
60. "An old rule of thumb holds that for every 10% increase in a company's size, the CEO's pay goes up 3%." David Wessel, With CEO Pay, Size Does Matter, Wall St. J., Nov. 2, 2006, at A2.
61. See, e.g., Jarrad Harford & Kai Li, Decoupling CEO Wealth and Firm Performance: The Case of Acquiring CEOs, 62 J. Fin. 917, 917 (2007) ("[E]ven in mergers where bidding shareholders are worse off, bidding CEOs are better off three quarters of the time.")
62. U.E. Reinhardt, Conglomerate Earnings per Share: Immediate and Post-Merger Effects, 47 Acct. Rev. 360, 363-64 (1972); David Harding & Phyllis Yale, Discipline and the Dilutive Deal, Harv. Bus. Rev., July 2002, at 18, 20; see also Gregor Andrade, Do Appearances Matter? The Impact of EPS Accretion and Dilution on Stock Prices 1 (June 1999) (unpublished manuscript), available at http://ssrn.com/abstract=172868.
63. The data in this graph are from Wharton Research Data Servs., supra note 18.
64. Carol Hymowitz, In the Lead: Pay Gap Fuels Worker Woes, WALL ST. J., Apr. 28, 2008, at B8 (reporting that average CEO pay in 2007 was more than 180 times average worker pay-twice the ratio in 1994).
65. Andrei Shleifer, Does Competition Destroy Ethical Behavior?, Am. Econ. Rev., May 2004, at 414, 415-16.
66. See Aggarwal & Samwick, supra note 38, at 65; Carol Callaway Dee, Ayalew Lulseged & Tanya S. Nowlin, Executive Compensation and Risk: The Case of Internet Firms, 12 J. Corp. Fin. 80, 94 (2005).
67. See, e.g., James A. Brickley, James S. Linck & Jeffrey L. Coles, What Happens to CEOs After They Retire? New Evidence on Career Concerns, Horizon Problems, and CEO Incentives, 52 J. Fin. Econ. 341, 342 (1999).
68. See supra p. 1002.
69. See, e.g., Richard A. Posner, Economic Analysis of Law 451-52 (6th ed. 2003).
70. See Restatement (Third) of Trusts § 227 (1992); Max M. Schanzenbach & Robert H. Sitkoff, Did Reform of Prudent Trust Investment Laws Change Trust Portfolio Allocation?, 50 J.L. & Econ 681 (2007).
71. See, e.g., Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (2000). For an overview of behavioral finance theory, see generally Nicholas Barberis & Richard Thaler, A Survey of Behavioral Finance, in 1B Handbook of The Economics of Finance: Financial Markets And Asset Pricing 1053, 1053-123 (George M. Constantinides, Milton Harris & René M. Stulz eds., 2003).
72. Shleifer, supra note 62, at 10
73. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified in scattered sections of 11, 15, 18, 28, and 29 U.S.C.).
74. See generally Bebchuk & Fried, supra note 3
75. Larry E. Ribstein, Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002, 28 J. Corp. L. 1, 4-6 (2002).
76. Kathleen A. Lacey, Barbara Crutchfield George & Clyde Stoltenberg, Assessing the Deterrent Effect of the Sarbanes-Oxley Act's Certification Provisions: A Comparative Analysis Using the Foreign Corrupt Practices Act, 38 Vand. J. Transnat'L L. 397, 404-14 (2005).
77. See Nicholas Varchaver & Katie Benner, The $55 Trillion Question, Fortune, Oct. 13, 2008, at 134, 134; Wall Street's Bad Dream: The Financial Crisis, Economist, Sept. 20, 2008, at 85, 85.
78. See Graef s. Crystal, in search of excess: the Overcompensation of the American Executive Passim (1991)
79. see also C. Terry Grant & Gerry H. Grant, Can Regulations Curb Excessive Executive Pay?, Strategic Fin., Sept. 2008, at 31, 36 (noting that the increase in the total median executive compensation between 1992 and 2006 outpaced the rate of growth in the net income and operating cash flows of the corresponding companies).
80. See Joshua A. Kreinberg, Note, Reaching Beyond Performance Compensation in Attempts to Own the Corporate Executive, 45 Duke L.J. 138, 145 (1995); John C. Gamboa & Mary Ann Mitchell, Editorial, The Fed Is Overlooking the Inflationary Effect of CEO Compensation, S.F. Chron., Apr. 20, 2000, at A27.
81. See, e.g., Bebchuk & Fried, supra note 43, at 88-89; see also Nakazato et al., supra note 17, at 9.
82. Ribstein, supra note 66, at 26-35; Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 Yale L.J. 1521, 1529-43 (2005). For strong empirical support, see Kate Litvak, The Effect of the Sarbanes-Oxley Act on Non-US Companies Cross-Listed in the US, 13 J. CORP. FIN. 195, 218-27 (2007).
83. Steven L. Schwarcz, Enron and the Use and Abuse of Special Purpose Entities in Corporate Structures, 70 U. Cin. L. Rev. 1309, 1315 (2002).
84. See, e.g., Comm'r v. Court Holding Co., 324 U.S. 331, 334 (1945); Gregory v. Helvering, 293 U.S. 465, 470 (1935); Yosha v. Comm'r, 861 F.2d 494, 499 (7th Cir. 1988).
85. Bebchuk et al., supra note 37, at 12-13; Daniel W. Collins, Guojin Gong & Haidan Li, The Effect of the Sarbanes-Oxley Act on the Timing Manipulation of CEO Stock Option Awards 20-23 (Nov. 16, 2005) (unpublished manuscript), available at http://ssrn.com/abstract=850564.
86. Brian J. Hall & Jeffrey B. Liebman, Are CEOs Really Paid Like Bureaucrats?, 113 Q.J. ECON. 653, 684-85 (1998).
87. See, e.g., Morgenson, supra note 28.
88. See Kara Scannell & Joann S. Lublin, SEC Issues Rules on Executive Pay, Options Grants, WALL ST. J., July 27, 2006, at C1.
89. See John B. Taylor, Economics 350 (2d ed. 1998).
90. See Lucian A. Bebchuk & Jesse M. Fried, Pay Without Performance: Overview of the Issues, 30 J. Corp. L. 647, 672-73 (2005).
91. Steve Lohr, In Bailout Furor, Wall St. Pay Becomes Target for Congress, N.Y. Times, Sept. 23, 2008, at A1.
92. See, e.g., Erin White & Aaron O. Patrick, Shareholders Push for Vote on Executive Pay, Wall St. J., Feb. 26, 2007, at B1.