Contracts and the Market for Executives

Sherwin Rosen

NBER Working Paper No. 3542
Issued in December 1990
NBER Program(s):Labor Studies

The paper reviews empirical findings on executive compensation in light of marginal productivity and contract theories. The executive labor market performs three functions. First, control must be distributed and assigned among executives. The most talented executives are efficiently assigned to control positions in the largest firms when talent and the marginal product of control are complements. These gains or rents are partially captured in larger earnings. In fact, the elasticity of top executive pay lies within a tight band around .25 among industries, time periods, and countries where it has been estimated. Second, executive contracts must provide incentives for managers to act in the interests of shareholders. Potential loss of reputation, bonding and takeovers probably substitute for direct monetary incentives in this task. Nevertheless, the elasticity of top executive pay with respect to accounting rates of return lie near 1.0. The elasticity with respect to stock market returns is much smaller, though precisely estimated, near 0.1. Differences of opinion remain on whether the market provides enough incentives to align interests between ownership and control. Third, the market must identify new talent and reassign control over careers from older to younger generations. Competition among executives for top positions and the diminishing incentive effect of future rewards with age implies that compensation should increasingly tilt rewards to current performance over the course of a career. Available evidence supports this prediction.

download in pdf format
   (389 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w3542

Published: Main Currents in Contract Economics, edited by Lars Werin and Hans Wijkander. Oxford: Blackwell Press, 1992.

Users who downloaded this paper also downloaded* these:
Gibbons and Murphy w3792 Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence
Gabaix and Landier w12365 Why Has CEO Pay Increased So Much?
Bebchuk and Fried w9813 Executive Compensation as an Agency Problem
Joskow and Rose w4976 CEO Pay and Firm Performance: Dynamics, Asymmetries, and Alternative Performance Measures
Frydman and Jenter w16585 CEO Compensation
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us