Christmas for some – The case of high top executive pay

In recent years the pay checks for top executives have kept on increasing. What is the mechanism behind this?

Economists talk about the agency problem, referring to the conflict of interest between a company’s management and the company’s stockholders. The manager, acting as the agent for the shareholders is supposed to make decisions that will maximize shareholder wealth. However, it is in the manager’s own best interest to maximize his own wealth.

While it is not possible to eliminate the agency problem completely, the manager can be motivated to act in the shareholders’ best interests through incentives such as performance-based compensation with stock and options. The trend of paying executives with stock, which surged during the late 1980s and 1990s, has clear consequences. It has made the CEOs of the biggest companies rich, as you can see in the graph below based on statistics from United States. Theoretically, paying executives with stock aligns their compensation with their performance. Practically, it means they stand to make absurd sums of money when stock prices rise.

Are the compensation levels well deserved or absurd? In a recent video on The Atlantic, Derek Thompson gives us his view on this question. He explains that CEOs are paid more because they’re paid differently. Below is the video from The Atlantic.

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