Executive Compensation: Six Questions That Need Answering

The big news this year isn't in the big numbers-it's in the fine print.Buried in the latest pay contracts chief executives are signing and the lists of stock-options they're salting away in the wall safe are the auguries and portents of things to come.Business Week, April 24, 1995, p. 88. There is a growing realization by the popular business press that a proper analysis of stock and option holdings is crucial to understanding U.S. executive compensation practices.The academic economics literature has also come to this conclusion, although only very recently.The economics literature on the effects of stock and options holdings is only in its infancy, but it has already yielded large dividends and has the potential for much more.In this article, we focus on how these recent advances can be used to address the following six questions: How much does executive compensation cost the firm?How much is executive compensation worth to the recipient?How well does executive compensation work?What are the effects of executive compensation?How much executive compensation is enough?Could executive compensation be improved?Our discussion will focus on the role of agency theory, which predicts that stock-based compensation will align executive and shareholder interests by linking the executive's compensation directly to increases in the market value of the company.Murphy (1999) reviews the extensive research on executive compensation.In this article, we consider instead some of the implications of that research and some important directions for future research.We begin by noting how U.S. CEO compensation policies compare with other y