1. Hall-Liebman (1998) Are CEOs Really Paid like Bureaucrats? n n 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 CEO’s 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? n 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 »CEO’s 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? n 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 ( ) for choosing A over B. –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? n Data –478 largest publicly traded U.S. companies. –1980-1994. n 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 firm’s stock. Compensation: Salary+bonus is $1.1 million, and stock options worth $325 thousand.

5. Hall-Liebman (1998) Are CEOs Really Paid like Bureaucrats? n Trends in CEO compensation (more fun facts to know and tell!) –Table IIb, Figure I –During 1980-1994 »Median salary+bonus 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. »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? n 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 CEO’s compensation( with stock) increases by 70.8% ($9.58 million). » »As firm performance declines from 50th to 30th percentile, CEO’s 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? n 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? n Change in sensitivity of CEO compensation to performance over time. n Table VIII n 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? n Policy Implications –Changes in value of stock and stock options completely outweigh changes in salary+bonus. »Salary+bonus not sensitive to performance: CEO pay levels set by boards who hire pay consultants to advise them. n Subjective judgements: CEO comparison group, performance measures, unusual circumstances, etc. n Consultants get fired for recommending (suggesting) pay cuts!

11. Hall-Liebman (1998) Are CEOs Really Paid like Bureaucrats? n 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)? n Jensen-Murphy paper. n Avoid public and media scrutiny (footnote 37). –Risk-avoidance behavior on part of CEO can be important. –Why no relative pay component?