CESifo Economic Studies - current issue

Introduction to the Symposium on Executive Pay

Englmaier, F., Illing, G., Sadka, E. — Wed, 07 Oct 2009 23:31:55 PDT

In Search of Reasonable Executive Compensation

Kandel, E. — Wed, 07 Oct 2009 23:31:55 PDT

This article makes several observations on the extent of executive compensation and the forms it takes, relating these to the recent literature. I argue that the magnitude of executive compensation seems excessive in light of a wide range of academic studies. I then propose specific regulatory measures that make compensation transparent and predictable for shareholders. Next, a simple taxation of executive compensation above a certain threshold is proposed; I argue that it is a much more efficient way to deal with the issue, than the current legislation in the United States. Turning to the ‘pay for performance’ paradigm, I argue that it must be applied with great care, as, along with the incentives to exert effort it also provides powerful perverse incentives, which are not immediately obvious, may vary dramatically across firms, and may not be well understood by the compensation committees and academics. I outline the design of several generic contracts appropriate for different environments. Finally, I stipulate that the downside of providing too much ‘pay for performance’ is especially evident in financial industry, which is opaque and subject to contagion, thus compensation contract should play a more important role in financial regulation. (JEL codes: G30, K22, M50)

How Much Sunlight Does it Take to Disinfect a Boardroom? A Short History of Executive Compensation Regulation in America

Dew-Becker, I. — Wed, 07 Oct 2009 23:31:55 PDT

This article reviews the history of executive compensation regulation in America and surveys the literature on the effects of these policies. CEOs are almost exclusively in the top 1% of the pay distribution, and regulation of their pay is seen as a well-targeted way of reducing income inequality. Mandatory disclosure of executive compensation has increased nearly uniformly since 1933. A number of other regulations, including special taxes on CEO pay and rules regarding votes on some pay packages have also been introduced, particularly in the last 20 years. However, there is little solid evidence that any of these policies have had any substantial impact on pay. I also review limited evidence from overseas on ‘Say on Pay’, recently proposed in the US, which would allow nonbinding shareholder votes on CEO compensation. The experiences of other countries have been positive, with tighter linkages between pay and performance and improved communication with investors. Mandatory say on pay would be beneficial in the United States, both increasing shareholder value and making CEO pay fairer, thus reducing the likelihood of passage of other legislation to reduce income inequality, such as higher taxes on the rich. (JEL-codes: J01, J08, J33, K22)

Learning from the Past: Trends in Executive Compensation over the 20th Century

Frydman, C. — Wed, 07 Oct 2009 23:31:56 PDT

In recent years, a large academic debate has tried to explain the rapid rise in CEO pay experienced over the past three decades. In this article, I review the main proposed theories, which span views of compensation as the result of a competitive labor market for executives to theories based on excess of managerial power. Some of these hypotheses have found support in cross-sectional evidence, but it has proven more difficult to determine which factors have caused the observed changes in pay over time. An alternative strategy is to evaluate the fit of plausible explanations out of sample by contrasting them with the evolution in executive pay and the market for managers during earlier time periods. A case study of General Electric suggests that evidence for earlier decades can speak of the recent trends and reveals the limitations of current explanations to address the long-run data. (JEL codes: G30, J33, M52, N82)

Strong Managers, Weak Boards?

Adams, R. B., Ferreira, D. — Wed, 07 Oct 2009 23:31:56 PDT

Many governance reform proposals are based on the view that boards have been too friendly to executives, for example, by awarding them excessive pay. Although boards are often on friendly terms with executives, it is less clear that they have systematically failed to function in the interests of shareholders. Understanding board monitoring requires a theory of boards that takes into account how firms provide incentives for their Chief Executive Officer's (CEOs) through other means. We develop a model in which a CEO's ownership stake and private benefits have opposite effects on his willingness to share private information with an independent board of directors. To encourage the CEO to communicate, the board may optimally commit to a low monitoring intensity when either CEO ownership is low or private benefits are high. Our model suggests that the existing cross-section evidence on the correlation between board composition and CEO ownership and tenure needs re-evaluation. Using a new proxy for board monitoring, we provide new evidence that this cross-sectional correlation appears to be non-monotonic, with board independence first decreasing and then increasing in CEO ownership and tenure. We discuss the implications of our model for the design and evaluation of governance structures. (JEL codes: G34, L22, J41, J44)

Insider Information and Performance Pay

Gayle, G.-L., Miller, R. A. — Wed, 07 Oct 2009 23:31:56 PDT

This article provides evidence that managers have private information they exploit for financial gain at the expense of shareholders. It develops a model of optimal contracting to show that moral hazard, hidden actions taken by agents, can rationalize why a principal would optimally induce agents to benefit from their private information. Estimates from a structural model shows that moral hazard is an important economic factor. This leads to the conclusion that, in practice, shareholders and managers might optimally agree upon an arrangement where managers systematically exploit their private information about the firm. (JEL codes: J3, K2, G3 and C5).

Taxes and Executive Compensation: Evidence from the 1990s

Katuscak, P. — Wed, 07 Oct 2009 23:31:57 PDT

This article analyzes the effect of personal income taxation on the pay-to-stock-price sensitivity of executive compensation contracts generated by stock option and restricted stock grants. Using Execucomp data for 1992–1996 and variation in the ordinary income marginal tax rate of top earners in the same time period, I find that an increase in the tax rate decreases the pre-tax pay-to-performance sensitivity generated by option grants, whereas stock grant sensitivity is found to be unresponsive to the same change. Even though these results can be explained by joint tax optimization of executives and their employers, they suggest that after-tax incentive provision for executives is quite sensitive to variation in the ordinary income tax rate. (JEL codes: D21, H24)

Bonus Payments and Fund Managers' Behavior: Transatlantic Evidence

Gehrig, T. P., Lutje, T., Menkhoff, L. — Wed, 07 Oct 2009 23:31:57 PDT

This questionnaire survey of fund managers in USA, Germany, and Switzerland documents a distinctly positive influence of bonus payments on investment behavior on both sides of the Atlantic. Higher bonus payments are significantly related to higher working effort but not to risk-taking. They also seem to induce fund managers to rely more on fundamental information. Findings within regions are confirmed by Transatlantic evidence as US fund managers receive larger bonuses but also show the effects to a higher degree. The effects documented are stronger for relative than for absolute performance assessment. (JEL-Codes: G23, G14)

Introduction to the Symposium on Poverty and Inequality in China

Whalley, J. — Wed, 07 Oct 2009 23:31:57 PDT

What Lies behind Rising Earnings Inequality in Urban China? Regression-based Decompositions

Deng, Q., Li, S. — Wed, 07 Oct 2009 23:31:58 PDT

Coupled with advances in enterprise reform and changes in the wage structure, earnings inequality in urban China has been increasing, and this has contributed significantly to rising income inequality. Using urban household survey data from the 1988, 1995 and 2002 waves of the China Household Income Project, in this article, we decompose earnings inequality in urban China by using the recently developed regression-based decomposition methods. The decomposition results indicate that the effects of gender and membership of the Communist Party of China on earnings inequality have changed little. While work experience had a reduced effect on earnings inequality, the effects of education and occupation have increased. The contributions of ownership status and industry to earnings inequality have increased. Regional effects have been the largest recent contributor to earnings inequality. (JEL codes: D31, J31, O53)

Power as a Driving Force of Inequality in China: How Do Party Membership and Social Networks Affect Pay in Different Ownership Sectors?

Li, S., Lu, M., Sato, H. — Wed, 07 Oct 2009 23:31:58 PDT

Party membership and social networks, as two forms of nonmarket power, have significant effects on personal income and act as driving forces of inequality in China. Do the effects vary across different ownership sectors (suoyouzhi xingshi)? Using a nationally representative survey of urban households (China Household Income Project surveys in 1995 and 2002), we find that (i) party membership can significantly increase personal income, but this effect does not significantly differ between different ownership sectors or between the years 1995 and 2002 and (ii) social networks are insignificant in state-owned enterprises (SOEs), while they contribute significantly to personal income in non-SOE sectors. Our finding does not predict a smaller inequality through lower returns to power during privatization in Chinese economy. (JEL codes: J40, O15, P26, Z13)

Rural Income Volatility and Inequality in China

Whalley, J., Yue, X. — Wed, 07 Oct 2009 23:31:58 PDT

Current literature based on analyses of rural income volatility in China decompose poverty into chronic and transient components using longitudinal survey data and assesses the fraction of the Foster, Greer, and Thorbecke poverty gap attributable to mean income over time being below the poverty line. Resulting estimates of 40–50% transient poverty point to the policy conclusion that poverty may be a less serious social problem than it appears in annual data due to rural income volatility. Here, we instead use a direct method to adjust rural income for volatility using a certainty equivalent income measure and recomputed summary statistics for the distribution of volatility corrected incomes, including the urban–rural income gap on which much of current poverty debate in China focuses. Available data indicate a growing urban–rural income gap (the ratio of mean urban to rural incomes) with a significant increase from around 1.8 in the late-1980s to over three today. These estimates do not take into account the higher volatility of rural incomes in China. Since an uncertain income stream is worth less in utility terms than a certain income stream, we argue that heightened rural volatility increases the effective urban–rural income gap and intensifies not weakens poverty concerns. Using Chinese longitudinal rural survey data for which current decompositions can be replicated, we make adjustments for certainty equivalence of rural household income streams, which not only widen the urban–rural income gap in China but also increase other distributional summary statistics. Depending upon values used for the coefficient of relative risk aversion, the measured urban–rural income gap increases by 20–30% using a certainty equivalent measure to adjust rural incomes for volatility. We also conduct similar analysis using consumption data, for which similar (but slightly larger) increases occur. (JEL codes: D00, D31, D81,G11, N55, O12; O15; R20)