HallLiebman 1998 Are CEOs Really Paid like Bureaucrats

1
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• To align the incentives of the CEO perfectly with
  that of the shareholders, pay the CEO 100 of the
  marginal returns of the firm. (Basically, sell
  the entire firm to the CEO). Impractical
• Financing constraint No one will lend a CEO
  substantially more than the CEOs net worth if
  the CEO can declare personal bankruptcy.
• Risk-aversion CEO bears diversifiable and
  non-diversifiable risk shareholders would have
  only borne the non-diversifiable risk. Capital
  market only rewards non-diversifiable risk.

2
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• How much sensitivity of pay-for-performance is
  needed for CEOs to make correct decisions?
• Jensen-Murphy (1990) suggest a number close to 1.
• Hall-Liebman consider various CEO activities
• CEOs choice of effort. (But CEOs are a
  self-selected group of high-effort, overachieving
  individuals.)
• Excess perquisite consumption.

3
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Most important CEO decision Choosing among a
  limited number of large discrete projects.
• Project A 500 million NPV private benefits to
  CEO of 3 million.
• Project B 400 million NPV private benefits to
  CEO of 5 million.
• CEO needs to be paid only 2 million more (not
  100 million more) for choosing A over B.

4
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Data
• 478 largest publicly traded U.S. companies.
• 1980-1994.
• Table I Fun facts to know and tell! In 1994,
  median CEO
• Is 58 years old, held the job for 6 years, worked
  in the company for 22 years ,
• Owns 0.14 of firms stock. Compensation
  Salarybonus is 1.1 million, and stock options
  worth 325 thousand.

5
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Trends in CEO compensation (more fun facts to
  know and tell!)
• Table IIb, Figure I
• During 1980-1994
• Median salarybonus increased by 85
• Median stock options increased from 0 to
  325,000.
• Figure I, 1980 30 CEOs received options, 1994
  70 received options.
• Table III (In earlier draft Figure 3) Growth
  in CEO compensation relative to other workers.
  All Workers compensation is mostly flat over this
  period.

6
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Sensitivity of CEO pay to firm performance
• Table V
• Considers changes in value of CEOs holdings of
  stock options and stock for different firm
  performance.
• Total compensation salary bonus stock
  grants option grants change in value of stock
  holdings change in value of option holdings
  other
• Total compensation for CEO at 10th decile is
  -435,000. At 90th percentile 8.6 million a
  difference of 9 million in just one year.
  Difference is about 29 million over 5 years
  (footnote 23).
• CEO wealth is (strongly) affected by firm
  performance!

7
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Table V and VI
• In improving firm performance from median (50th
  percentile) to 70th percentile, the CEOs
  compensation( with stock) increases by 70.8
  (9.58 million).
• As firm performance declines from 50th to 30th
  percentile, CEOs compensation declines by 50.7
  (8.4 million).
• (Median dollar figures are much less increase of
  about 2 million, decrease of 2 million.)
• Above suggests that CEO compensation is quite
  sensitive to firm performance!

8
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Sensitivity of CEO pay to firm performance
• Table VIII Elasticity (change in compensation)
  / (change in stock price)
• All positive.

9
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Change in sensitivity of CEO compensation to
  performance over time.
• Table VIII
• All four measures of sensitivity of CEO
  compensation to performance show significant
  increase from 1980 to 1994.

10
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Policy Implications
• Changes in value of stock and stock options
  completely outweigh changes in salarybonus.
• Salarybonus not sensitive to performance CEO
  pay levels set by boards who hire pay consultants
  to advise them.
• Subjective judgements CEO comparison group,
  performance measures, unusual circumstances, etc.
• Consultants get fired for recommending
  (suggesting) pay cuts!

11
Hall-Liebman (1998) Are CEOs Really Paid like
Bureaucrats?

• Policy Implications (continued)
• Why has sensitivity of pay to performance
  increased so much over the past 15 years (due to
  increased use of stock and stock options)?
• Jensen-Murphy paper.
• Avoid public and media scrutiny (footnote 37).
• Risk-avoidance behavior on part of CEO can be
  important.
• Why no relative pay component?