Abstract - Capping CEO Pay

"We review several recent proposals to limit CEO pay. We incorporate the proposed restrictions into two models of executive compensation and calibrate these models to the data. This approach allows us to predict how firms react to the restrictions and how the restrictions affect shareholder wealth.
We find that firms can easily and at little additional cost circumvent light restrictions on total pay or restrictions on individual pay components. However, such regulation can result in dramatically different CEO contracts and in unintended consequences like high rewards for mediocre performance, increased CEO turnover, less incentives to take risks, and higher managerial rents.
If faced with severe restrictions on total pay that cannot be circumvented, firms hire less talented CEOs and provide less effort incentives at a potentially high cost to shareholders. Our model predicts that a reduction of total pay by 50% results in a drop in firm value by 30% if the CEOs' outside employment opportunities are not affected by the regulation."

Ingolf Dittmann
Erasmus School of Economics, Rotterdam
17.Nov 2009

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