Executive Compensation: A New View from a Long-Term Perspective

In our paper, Executive Compensation: A New View from a Long-Term Perspective, 1936-2005, which is forthcoming in the Review of Financial Studies, we document important changes in the level and the structure of executive pay from 1936 to 2005. The real value of total compensation followed a J-shaped pattern over our sample period. After a sharp decline during World War II, the level of pay increased at a modest rate from the mid-1940s to the mid-1970s, and then rose at an increasing rate from the 1970s to the present. The composition of executive compensation also changed considerably since the 1950s, as both stock options and other forms of incentive pay became larger shares of total compensation over time.

The relative stagnation of compensation during the 1950s and 1960s is surprising because the level of executive pay did not keep pace with the growing size of firms during this period. By contrast, pay and firm size have been more strongly correlated in recent decades. Decomposing the relationship between compensation and firm size into its cross-sectional and time series components, we find that the cross-sectional relationship has remained relatively stable over the past 70 years. On the other hand, while the level of pay moved almost one-to-one with the average market value of firms over the past 30 years, this correlation was one-tenth to one-third as large in the 1946-1975 period. Moreover, the strong correlation that we find in the later period may be biased upward by spurious correlation in the market value of firms and the level of pay.

The transformation in the structure of compensation over the past fifty years has important implications for managerial incentives because incentive pay ties an executive’s wealth to the performance of the firm. Using a broad measure of executive compensation that includes salaries, bonuses, stock option grants, and revaluations of stock and stock option wealth, we find that the pay-performance sensitivities were considerable in most decades except the 1940s and the 1970s. Thus, compensation arrangements have served to tie the wealth of managers to firm performance — and perhaps to align managerial incentives with shareholders’ interests — for most of the twentieth century.

The long-run trends in executive compensation allow us to reassess several common explanations for changes in the level and structure of pay over the past several decades. The data prior to the 1970s are inconsistent with theories of managerial rent-seeking, a competitive labor market for executives, and increases in managerial incentives. These explanations may still help to explain the recent surge in compensation, but only if the determinants of executive pay were different in the past. Plausible reasons for such a shift may involve changes in the nature of the tasks carried out by top executives, or in social norms that may have constrained inequality in earlier decades. By providing a contrast to recent data, the long-run trends in managerial pay present a challenge that we hope will further our understanding of the determinants of executive compensation.

The full paper is available for download here.