Why has CEO Pay Increased So Much?*

Abstract

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 depends on both the size of his firm and the aggregate firm size. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. In recent decades at least, the size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries. In particular, in the baseline specification of the model's parameters, the sixfold increase of U.S. CEO pay between 1980 and 2003 can be fully attributed to the sixfold increase in market capitalization of large companies during that period.

*

We thank Hae Jin Chung and Jose Tessada for excellent research assistance. For helpful comments, we thank our two editors, two referees, Daron Acemoglu, Tobias Adrian, Yacine Ait-Sahalia, George Baker, Lucian Bebchuk, Gary Becker, Olivier Blanchard, Ian Dew-Becker, Alex Edmans, Bengt Holmstrom, Chad Jones, Steven Kaplan, Paul Krugman, Frank Levy, Hongyi Li, Casey Mulligan, Kevin J. Murphy, Eric Rasmusen, Emmanuel Saez, Andrei Shleifer, Robert Shimer, Jeremy Stein, Marko Tervio, David Yermack, Wei Xiong, and seminar participants at Berkeley, Brown, Chicago, Duke, Harvard, the London School of Economics, the Minnesota Macro Workshop, MIT, NBER, New York University, Princeton, the Society of Economic Dynamics, Stanford, the University of Southern California, and Wharton. We thank Carola Frydman and Kevin J. Murphy for their data. XG thanks the NSF (Human and Social Dynamics Grant 0527518) for financial support.