Do CEOs Set Their Own Pay? The Ones Without Principals Do


We empirically examine two competing views of CEO pay. In the contracting view, pay is
used to solve an agency problem: the compensation committee optimally chooses pay contracts
which give the CEO incentives to maximize shareholder wealth. In the skimming view, pay
is the result of an agency problem: CEOs have managed to capture the pay process so that
they set their own pay, constrained somewhat by the availability of cash or by a fear of drawing
shareholders’ attention. To distinguish these views, we first examine how CEO pay responds
to luck, observable shocks to performance beyond the CEO’s control. Using several measures
of luck, such as changes in oil price for the oil industry, we find substantial pay for luck. Pay
responds about as much to a “lucky” dollar as to a general dollar. Most importantly, we find that
better governed firms pay their CEOs less for luck. Our second test examines how much CEOs
are charged for the options they are granted. Since options never appear on balance sheets, they
might offer an appealing way to skim. Here again we find a crucial role for governance: CEOs
in better governed firms are charged more for the options they are given. These results suggest
that both views of CEO pay matter. In poorly governed firms, the skimming view fits better
(pay for luck and little charge for options) while in well governed firms, the contracting view
fits better (filtering out of luck and charging for options).

Year of Publication
Date Published
Publication Language
Citation Key
Working Papers