Explaining Executive Compensation: Managerial Power versus the Perceived Cost of Stock Options

Abstract

The 1990s were a great time to be a top executive in a large U.S. company. Figure 1 shows the median total compensation of chief executive officers in S&P 500 Industrials (that is, the S&P 500 companies excluding utilities and finance firms) from 1992 through 2000. The bar height depicts median total compensation in CPI-adjusted 2001constant dollars, including salaries, realized bonuses, stock options, and other pay.' Over this period, median total compensation nearly tripled from $2.3 million in 1992 to over $6.5 million in 2000. Figure 1 also depicts how the composition of CEO pay has evolved over time.2 The figure shows that the increase in CEO pay in S&P 500 Industrials during the 1990s primarily reflects a dramatic growth in stock options (valued on date of grant), which swelled from 27 percent to 51 percent of total compensation, representing a five-fold increase in dollar terms. Table 1 shows that the option-driven escalation in CEO pay levels is not limited to S&P 500 Industrials. Panel A shows that median pay in S&P 500 Financial Services companies increased 300 percent, from $2.6 million to almost $11 million from 1992 to 2000, while pay in smaller firms (defined as companies in the S&P MidCap 400 and SmallCap 600) more than doubled, from $823,000 to $1.8 million. Median pay in so-called New Economy firms increased 130 percent, from $1.4 million to $3.2 million.3 Panel B shows that the large pay in-