Executive compensation and incentives

The objective of a properly designed executive compensation package is to attract, retain, and motivate CEOs and senior management. The standard economic approach for understanding executive pay is the principal-agent model. This paper documents the changes in executive pay and incentives in U.S. firms between 1993 and 2003. We consider reasons for these transformations, including agency theory, changes in the managerial labor markets, shifts in firm strategy, and theories concerning managerial power. We show that boards and compensation committees have become more independent over time. In addition, we demonstrate that compensation committees containing affiliated directors do not set greater pay or fewer incentives.