Are CEOS Really Paid Like Bureaucrats?

The common view of CEO compensation is that there is essentially no correlation between firm performance and CEO pay. This calls into question an important component of effective corporate governance. This "zero correlation" belief is based on the widely cited result that CEO wealth rises by only $3.25 for every $1,000 increase in firm value (Jensen and Murphy, 1990b) and findings that the elasticity of CEO salary and bonus with respect to firm market value is only 0.1. Using a new 15-year panel data set of CEOs in large U.S. firms, we report a variety of pay-to-performance measures using a broad measure of CEO compensation that includes changes in the value of CEO holdings of stock and stock options. We find that CEO compensation is highly responsive to firm performance. For example, for only a moderate change in firm performance (moving from a median stock price performance to a 70th percentile performance), the compensation of the median CEO in our sample increases by almost 50 percent, which represents about $1.5 million. We estimate that the elasticity of CEO compensation with respect to firm value is 3.3 (at the median) for 1994. This value is 20 to 30 times larger than previous elasticity estimates that ignore the effects of changes in the value of stock and stock option holdings. We also document that both the level of CEO compensation and the sensitivity of CEO compensation to firm performance have grown dramatically over the past 15 years. In our sample, the compensation of the mean (median) CEO increased by 207 percent (146 percent) from 1980 to 1994. The large increase in stock option awards and in the value of stock holdings has approximately doubled pay-to-performance sensitivities over this period