CEO pay redux

Managerial power theory holds that structural flaws in corporate governance, such as board defenses, enable opportunistic managers to extract excessive pay. While this theory has proven highly influential, this Article argues that it fails to answer important questions. For example, how does managerial power theory relate to the prevailing economic paradigm of CEO pay as reflecting competition for scarce managerial talent? Further, how can one reconcile the theory’s negative account of board protection with recent empirical studies showing that such protection is value increasing? In investigating these and other questions—both theoretically and empirically—this Article makes four contributions. First, it shows that adopting defensive measures (such as the staggered board) is not associated with significant changes in CEO pay. Second, it documents that greater competition for managerial talent is positively associated with CEO pay. Third, it shows that higher CEO pay is associated with higher firm value, especially in firms with a staggered board. Fourth, it provides plausible causal evidence that the decline in stock options (i.e., high-powered incentives) that followed the 2005 mandate to expense options is associated with increased firm value. These results suggest that high executive pay serves to attract talented managers, rather than reflecting managerial opportunism. They also suggest that board protection might be beneficial to prevent market pressure from introducing value-reducing distortions in executive pay, such as an excessive use of high-powered incentives emphasizing short- over long-term performance. The Article concludes by discussing the policy implications of the analysis.