Executive Compensation: Is It Better to be Lucky than Good?

Abstract

Why, exactly, are executives paid so much? Executive compensation has for years sparked interest from Main Street (citizens) to Wall Street (shareholders) to Capitol Hill (legislators) to Harvard Square (academia). Assertions of overpayment, fair payment, and more rarely, underpayment, abound. This is because executive compensation represents not only a signifi cant fi nancial commitment, but compared to rank-and-fi le positions, executive compensation is tremendous. Take 2012 as an example. While the median annual wage for U.S. workers hovered around $40,000 per year, median CEO pay was nearly 250 times that—almost $10 million. And although average worker pay has barely increased for years, CEO pay is on the rise again following the recession that began in 2008. The lack of consensus among scholars regarding the rationale for executive pay has only muddied the waters. Some argue that managerial skill determines pay; others contend that competitive labor market forces generate these pay scales; and, still others say pay simply results from the luck of working for the right fi rm in the right industry at the right time. To clarify this muddied picture, Jeffrey Brookman (Idaho State University) and Paul Thistle (University of Nevada at Las Vegas) performed a “horse race” to determine whether skill, competitive forces, or luck best explains executive salaries. They ultimately conclude executives are compensated for their skills.