The case study entitled " Learning from the Past: Trends in Executive Compensation over the 20th Century" and prepare a three page summation using the process we presented in Module One for case study's taken from The Case Study Handbook by William Ellet.
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Learningfrompast.pdf
Learning from the Past: Trends in Executive
Compensation over the 20th Century
Carola Frydman*
Abstract
In recent years, a large academic debate has tried to explain the rapid rise in CEO pay
experienced over the past three decades. In this article, I review the main proposed
theories, which span views of compensation as the result of a competitive labor market
for executives to theories based on excess of managerial power. Some of these hypoth-
eses have found support in cross-sectional evidence, but it has proven more difficult to
determine which factors have caused the observed changes in pay over time. An alterna-
tive strategy is to evaluate the fit of plausible explanations out of sample by contrasting
them with the evolution in executive pay and the market for managers during earlier time
periods. A case study of General Electric suggests that evidence for earlier decades can
speak of the recent trends and reveals the limitations of current explanations to address
the long-run data. (JEL codes: G30, J33, M52, N82)
Keywords: Executive compensation, managerial incentives, corporate governance,
market for managers.
1 Introduction
As the main decision makers in large public corporations, top executives
comprise an important albeit small part of the labor force. Thus, the
compensation of these individuals is of special interest because it influ-
ences their decision-making process. Since the 1980s, the academic
research on executive pay has grown significantly (Murphy 1999). This
new interest on the topic is probably related to two main reasons. First,
the level of executive compensation has soared since the 1970s, due in part
to the increasing use of employee stock options (Hall and Liebman 1998,
Murphy 1999). In consequence, both the high levels of pay and the struc-
ture of compensation have come under intense scrutiny. Second, compre-
hensive datasets with detailed information on the compensation of top
managers are available for this period, allowing a precise determination
of the stylized facts on pay over the past three decades. The recent trends in executive pay have generated a considerable debate
on the determinants of compensation. Proposed theories cover a wide
spectrum, ranging from viewing the level of pay as the efficient outcome
* MIT Sloan School of Management, 50 Memorial Drive Room E52–436, Cambridge MA, 02142, USA, e-mail: [email protected]. I thank the participants at the CESifo Venice Summer Institute Workshop on ‘‘Executive Pay’’ held on July 16–17 2008 for their comments.
� The Author 2009. Published by Oxford University Press on behalf of Ifo Institute for Economic Research, Munich. All rights reserved. For permissions, please email: [email protected] 458
CESifo Economic Studies, Vol. 55, 3-4/2009, 458–481 doi:10.1093/cesifo/ifp021 Advance Access publication 25 August 2009
from a competitive labor market for managers to arguing that extremely
high pay is the result of managers inefficiently extracting rents from the
firms they manage. While some of the proposed hypotheses have found
support in cross-sectional evidence, identifying the drivers of pay over time
has proven more difficult. Since the 1970s, the level of executive pay has
exhibited a steady upward trend. The potential determinants of pay sug-
gested by most of these theories have also changed mostly monotonically during this period, leading to a systematic correlation between these vari-
ables and executive pay. Thus, it is difficult to disentangle which of the
proposed explanations has mattered in a more causal manner focusing
only on evidence for recent years (Frydman and Saks 2009). An alternative strategy consists of verifying the predictions of various
theories by using data for other countries or other time periods. A sub-
stantial literature has established how compensation practices vary across
countries and is now starting to evaluate different theories on pay using
these data. 1 Information on managerial pay from other periods in US
history is also a valuable addition because other periods provide more variation in the trends in pay and in the determinants to be assessed
with arguably less variation in institutions than in cross-country studies.
Frydman and Saks (2009) present such a study by setting forth the long-
run changes in compensation in a systematic manner and quantitatively
analyzing the contribution of several explanations to the trends in pay
over time. In this article, I build on that work by focusing on the evolution
of compensation and managerial backgrounds of the top executives of
General Electric Corporation (GE). This qualitative case study addresses
a larger set of theories for the recent changes in pay and provides a more
involved view on the uses of historical data than was possible in Frydman
and Saks (2009). The lead explanations for the recent rise on executive pay can be broadly
divided into two categories. First, a set of theories views compensation as
the competitive outcome from the labor and product markets. These
explanations encompass the role of demand for talent and scale effects;
increase in the demand for generalist CEOs; the effects of trade and prod-
uct market competition; and the emergence of alternative outside options
for managers. 2 A second set of theories emphasizes the constraints that
institutions, either within or outside corporations, impose on executive
pay. The main hypotheses in this group include managers’ ability to
1 See, for example, Abowd and Bognanno (1995) and Fernandes et al. (2008) for a descrip- tion of the international differences in executive compensation. Llense (2008) applies the Gabaix and Landier (2008) model to French data.
2 For a detailed review of optimal contracting theories applied to CEO pay, see Edmans and Gabaix (2009).
CESifo Economic Studies, 55, 3-4/2009 459
Executive Compensation over the 20th Century
extract rents from firms with weak corporate governance; the monitoring
performed by large shareholders; the effects of peer benchmarking; and
the role of social norms. I summarize these explanations, making an
emphasis on the limitations that each one has in accounting for the
changes in compensation over time using only data for the last three
decades. While earlier data provide an alternative ‘laboratory’ to analyze the
different theories on executive compensation, a potential concern is that
the organization of firms has evolved significantly over time. However, the
experience of public corporations during earlier decades is relevant for the
policies implemented in recent years. The role of top managers has not
changed significantly since the separation of corporate ownership from
corporate control at the turn of the 20th century (Chandler 1977, Berle
and Means 1991). Thus, the main issues concerned with the remuneration
of corporate executives have been prevalent over the longer run. To provide an involved view of the changes and challenges experienced
by firms over the longer run, I review the experience of GE. The history of
this successful corporation serves to illustrate a significant evolution in the
compensation and the labor market for top managers over time. Relative
to the evidence for the past three decades, the level of pay of GE’s execu-
tives was significantly lower and grew at a slower rate from the 1940s to
the 1970s. 3 The characteristics of GE’s managers have also changed, from
the executives having education mostly in engineering or law earlier in the
century to a more diverse educational background since the 1960s.
Moreover, recent managers have worked in different sectors of the firm,
potentially acquiring skills that are more general in nature. The acquisition
of general human capital may have allowed internal candidates for the
CEO position to leave the firm for corporations in different industries
when passed up for the chief executive job. Since the trends for GE are not unique to this corporation, the historical
evidence suggests that assessing the mechanisms that determine executive
pay is still an important challenge. Most of the proposed theories for the
recent decades do not seem to fit well with the data on compensation and
the characteristics of managers prior to the 1970s. Thus, future work on
executive compensation can learn from the past to further our understand-
ing of the present.
3 This pattern in the evolution of compensation for GE’s top managers is similar to the trend in pay of the larger sample of firms analyzed in Frydman and Saks (2008).
460 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
2 The current debate on the determinants of the growth
in executive pay
Many different theories have been proposed to explain the recent rise in CEO pay. While difficult to categorize them, these explanations can broadly be divided between theories that view the level of executive pay as a result of competitive forces in the labor and product markets and theories that argue that institutions either within or outside the firm influ- ence the level of pay. I summarize the most popular explanations within these two groups and assess their limitations for explaining the evolution of executive compensation over time.
2.1 Competition and executive compensation
2.1.1 Demand for talent and scale effects
In recent years, the view that executive pay is the optimal response to supply and demand forces within a competitive labor market for execu- tives has gathered increasing support. Models such as Rosen’s (1981, 1982) propose that competition for scarce managerial talent leads to relative higher pay in larger firms in a given year. The marginal product of a CEO’s effort is higher in larger firms because the ability of the chief exec- utive trickles down a larger number of hierarchical layers. Consequently, competition leads to positive assortative matching between managerial ability and firm size. More recently, this idea has been adapted to explain the growth in
compensation over time (Tervio 2009). Within this framework, Gabaix and Landier (2008) argue that changes in the level compensation over time should be determined by the growth in the size of the typical firm in the economy. Indeed, they find a one-to-one correlation between CEO pay and the market capitalization of the median firm among the largest 500 since the 1970s. According to their view, an increase in the scale of firms completely explains the growth in CEO pay over time. The assessment of this theory presents two main empirical challenges.
First, a correlation between the level of CEO compensation and median firm size does not imply a causal relationship between these two measures. Moreover, the documented empirical relationship does not establish that the underlying mechanism generating this correlation is actually caused by the assignment of scarce managerial talent to firms in a competitive market.
2.1.2 Changes in the types of managerial skills
A related view that also relies on a competitive labor market for executives argues that the increase in compensation can be explained by a shift in the type of skills that firms demand, from firm-specific human capital to
CESifo Economic Studies, 55, 3-4/2009 461
Executive Compensation over the 20th Century
general managerial skills (Murphy and Zábojnı́k 2004). This theory pre-
dicts that, as general skills become relatively more important, average pay
increases, more CEOs are hired from outside the firm, and the disparity
between CEO pay and other top executives at the corporation increases
(Murphy and Zábojnı́k 2004, Frydman 2007). This explanation fits well the rising mobility of executives experienced in
recent decades. While only 15% of new CEO appointments were hired
from outside the firm in the 1970s, almost 33% of the chief executives
selected from 2000 to 2005 were outsiders (Murphy and Zábojnı́k 2007).
However, a main challenge for this theory is to quantify managerial skills.
Moreover, changes in the demand for skills, which is most likely related to
the production function of firms, probably occurred slowly over time.
2.1.3 Trade and product market competition
Because labor markets receive a negative signal on the quality of the man-
agerial team when a firm’s performance suffers, competition in the prod-
uct market may serve as an alternative mechanism to explicit wage
contracts in the disciplining of managers (Fama 1980). However, recent
research argues instead that more high-powered incentives are needed
when product markets are more competitive. In periods of globalization,
technological innovation, and deregulation, the complexity of the respon-
sibilities of top management increases, thereby increasing the demand for
talented executives. Thus, higher performance pay is required to attract
and provide incentives to top managers. Because a higher level of pay is
needed to compensate risk-averse executives for the extra risk added by
incentives, the recent growth in pay may be the result of more competition
in product markets. An advantage of this explanation is that allows for a cleaner identifica-
tion strategy than most other theories on executive pay. For example,
Cuñat and Guadalupe (2009b) find that the sensitivity of pay to firm
performance, the inequality among top managers within the firm, and
the probability of turnover increase when competition (measured by
import penetration) becomes more pronounced. Moreover, pay-
performance sensitivities also increase when industries deregulate
(Hubbard and Palia 1995, Cuñat and Guadalupe 2009a). Although exog-
enous shocks to competition provide a valuable identification strategy,
this methodology is more useful for identifying effects of competition on
pay-to-performance than on the level of pay. Moreover, a drawback of
using such a precise strategy is that it allows for identifying only very
particular aspects of competition. Thus, a large fraction of the variation
in pay over time remains unexplained within this framework.
462 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
2.1.4 The rise of finance and outside options for corporate managers
In most models proposing a competitive labor market for executives, the level of pay is positively associated with the outside option of top man- agers. Thus, the recent rise in executive pay could be related to an increase in the reward that CEOs can obtain in alternative activities. In recent decades, the opportunities and the gains in the financial sector have devel- oped dramatically (Kaplan and Rauh 2009). Thus, the increase in CEO pay may be an equilibrium effect if highly paid jobs in finance are a plausible alternative for top managers. For this argument to hold, the skills to become a successful leader in
large public companies and in the financial sector should be close substi- tutes. However, little is known about the relevant labor market for CEOs and other top executives. The supply of executives and the alternative jobs that these individuals could engage in is largely unknown, making it extre- mely difficult to quantitatively assess this hypothesis.
2.2 Institutional factors inside and outside the firm
2.2.1 Corporate governance and extraction of rents
A large literature has suggested that the high level in executive compen- sation is the result of CEOs ability to extract rents from the firm (Bebchuk and Fried 2003, 2004). When firms’ boards of directors are not strong to limit the power of CEOs, chief executives acting in a self-interested manner will skim the firm. According to this view, the level of executive pay is excessive and inefficient. Moreover, proponents of this view argue that the structure of pay is also the result of poor corporate governance, as entrenched executives find it easier to reward themselves with lavish pay- checks in forms of compensation that are less observable or harder to value, as employee stock options, pensions, perquisites, and severance payments. Given some highly publicized cases of managerial power leading to out-
rageous compensation packages and perks, this hypothesis has some merit. Moreover, differences in corporate governance seem to influence the specific behavior of executive pay. For example, CEOs in firms with weak boards are rewarded for lucky events that increase firm value but that are arguably independent of their actions. However, chief executives also receive hefty paychecks in firms with strong governance with the intent to provide incentives (Bertrand and Mullainathan 2001). Thus, managerial skimming may be the correct explanation for the level of com- pensation in a few firms, but it is less obvious that this theory can account for the changes in the median level of pay. While rent extraction may help explain some of the variations in pay in
the cross-section, it is more unlikely that the trend in pay over time is due
CESifo Economic Studies, 55, 3-4/2009 463
Executive Compensation over the 20th Century
to governance practices alone. A steady worsening in the corporate gov-
ernance of US corporations may help explain the explosion in pay and in
stock option use since the 1980s, but most available proxies for gover-
nance show no deterioration over this period. 4 Moreover, even a correla-
tion between governance measures and the level or structure of pay does
not imply that the relationship between these variables is causal. Since the
governance structure is an endogenous choice of corporations, identifying
causality is particularly difficult in this context.
2.2.2 Direct monitoring of large shareholders
Although high levels of pay are usually linked to poor corporate gover-
nance, an alternative view claims that this trend could be associated with
improvements in governance. As corporate governance strengthens,
boards become more diligent and independent. As a consequence,
boards are more likely to fire underperforming CEOs who will be less
able to become entrenched. Thus, the increase in CEO pay could be a
response to the decline in job stability faced by top managers as boards’
monitoring ability improves (Hermalin 2005). Several pieces of evidence are consistent with this hypothesis. The sta-
bility of top management positions has deteriorated, as indicated by the
rising likelihood of forced turnover since the 1970s (Huson, Parrino, and
Starks 2001) and the decline in CEO tenure since the mid-1990s (Kaplan
and Minton 2006). Moreover, boards’ ability to monitor CEOs has likely
improved in recent years. 5 However, arguments similar to those made in
Section 2.2.1 highlight the difficulties of empirically evaluating this theory
with available data.
2.2.3 Peer benchmarking
Most corporations set CEO pay using as a benchmark the compensation
at a peer group composed of similar companies. The practice of com-
petitive benchmarking is regarded as generating a ratchet effect that
leads to continuous growth in the level of pay (Murphy 1999). To signal
to the market that the incumbent CEO is of high-quality, firms award their
chief executives a level of compensation above median pay in their rele-
vant peer group. 6 If boards set compensation in this manner, the median
4 For example, a comprehensive index based on corporate governance provisions and state laws indicates no change in shareholders’ rights for the median or average firm among 1500 large corporations over the 1990s (Gompers et al. 2003).
5 For example, the presence of independent directors at boards has increased over time (Lehn et al. 2003).
6 A pay level below the 50th percentile is often labeled ‘below market’, perhaps providing a negative signal to the market.
464 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
level of pay increases every year independent of the performance of the firm, leading to excessively high remuneration. Arguably, the role of compensation consultants in the determination of
CEO pay has increased since the 1970s (Khurana 2002). However, this fact alone does not validate peer benchmarking as a major force in the growth
of compensation. Indeed, Bizjak, Lemmon and Naveen (2008) suggest that the practice of peer benchmarking may be an efficient way to determine the value of a CEO in a competitive market and retain managerial talent. In particular, they find that peer-group benchmarking is more correlated to economic factors (measured by the labor market conditions and firm
performance) than to the corporate governance of firms.
2.2.4 Social norms
The growth in top management pay experienced in the USA since the 1970s happened concurrently with a pronounced increase in income
inequality. The disparity in pay was driven mostly by an expansion in income levels at the top of the distribution (Piketty and Saez 2003). Thus, it is possible that the factors driving these two phenomena are related. I analyzed two of the main hypothesis for the change in income inequality (trade and skilled-biased technical change) and their relevance
for executive pay in Section 2.1. However, a third main factor to be con- sidered is changes in social norms. According to this view, the rise in income inequality in the past three decades is a consequence of the removal of social norms that constrained the level of pay in the postwar period (Piketty and Saez 2003, Levy and Temin 2007). A limitation of this hypothesis is that social norms are not easily quan-
tifiable, making it difficult to assess the importance of this explanation
empirically. Thus, the relevance of social norms for the trends in executive compensation is difficult to validate or disprove.
3 Learning from the past: executive compensation as a
longer-run concern
Using a cross-section of firms, the empirical evidence appears to support many of the theories discussed in Section 2. Which ones, then, can account for the changes in executive compensation over time? Most of the pro- posed arguments rely on measures that have changed monotonically since the 1970s. Because executive pay was mostly trending upward during this
period, there is little evidence on a causal relationship between each of the relevant variables and the changes in compensation over time. Thus, as argued in more detail by Frydman and Saks (2009), the determinants for the time-series of executive pay are not well established.
CESifo Economic Studies, 55, 3-4/2009 465
Executive Compensation over the 20th Century
To better understand the mechanisms responsible for the evolution in
the level and structure of pay over time, a viable channel is to look for
alternative sources of variation to evaluate the validity of each theory out
of sample. 7 One plausible source is to focus on an earlier time period,
when the changes in executive compensation were considerably different.
This exercise is relevant because, as I argue in Section 3.1, the compensa-
tion of top executives has been a main problem for corporations ever since
the separation of corporate ownership from corporate control during the
beginning of the 20th century (Berle and Means 1991). Moreover, I show
in the next section that analyzing executive pay during earlier decades is
possible because systematic data on the remuneration of top managers is
available since the mid-1930s.
3.1 Earlier evidence on managerial pay
In the early 20th century, compensation practices were closely guarded
secrets. In consequence, only scattered historical evidence exists on execu-
tive salaries at that time. 8 Revelations regarding executive pay first
occurred during World War I, when railroad corporations became man-
aged by the federal government and the exorbitant salaries of railroad
officers were exposed. Public scrutiny intensified during the 1920s, and
information on the compensation of railroad and banking executives was
published in the popular press. 9
By the early 1930s, the controversy surrounding the level of pay had
extended to executives in all businesses. As the economy slipped into the
Depression, the nation became increasingly troubled by the ‘‘lavish sti-
pends and bonuses’’ accruing to the managers of large public corpora-
tions. 10
Prompted by these concerns, the Reconstruction Finance
Corporation, the Federal Trade Commission, and several other institu-
tions requested information on the compensation of officials in firms
under their respective jurisdictions. 11
These dispersed efforts to monitor
7 This argument follows Frydman and Saks (2009). In this article, I extend their analysis to a larger set of theories that can be studied in the context of a case study.
8 Court records are a possible source of information for this period, because they occa- sionally reveal the remuneration of corporate officers (Baker 1938). Alternatively, one could rely on payroll records from individual firms.
9 See, for example, ‘‘Explains Big Salary of Railroad Head. Charles Frederick Carter Says Competent President Earns it Many Times’’, New York Times, 24 December 1922; ‘‘Comptroller Seeks Salary Data From National Banks’’, Wall Street Journal, 25 February 1921; ‘‘Commerce Commission Goes Into Executives’ Salaries’’, Wall Street Journal, 23 December 1922; ‘‘They Earn Their Salaries’’, Wall Street Journal, 27 February 1923.
10 ‘‘Inquiry into High Salaries Pressed by the Government’’, New York Times, 29 October 1933.
11 For example, the Federal Trade Commission was directed to collect information on the salaries of executives from the companies listed in the NYSE in 1933 (Senate Resolution No. 75, 73rd Congress).
466 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
the compensation practices of major corporations were centralized with
the establishment of the Securities and Exchange Commission (SEC)
in 1934. Created to enforce the Securities Exchange Act of 1934, the SEC was
put in charge of the disclosure of data by firms participating in the secu-
rities market, thereby regulating corporate finance (Seligman 2003).
Disclosure of information related to the remuneration of executive officers
and directors was intended to deter managers from engaging in wrongful
behavior and mismanaging corporate assets (Loss and Seligman 1995).
Thus, the inception of the SEC has made executive compensation data
available to the public from the 1930s to the present. These data, reported in 10-K reports and proxy statements, have been
used by researchers to analyze executive compensation at several points in
time and, more recently, systematically by Frydman and Saks (2009), pro-
viding a consistent view of how compensation evolved over the longer run.
Thus, the theories proposed to explain evolution of pay over the past 30
years should be contrasted against the now well-established facts on exec-
utive compensation over most of the 20th century.
3.2 A case study of executive compensation at GE
To provide a more involved view of the changes in compensation policies
and in the labor market for managers over time, I use the history of GE as
an illustration. This corporation is a primary example of corporate, finan-
cial, and technological success of the 20th century. 12
3.2.1 Brief history of GE
GE was constituted as a firm that operated in the electrification business
in 1892 when Edison Electric Light Company, founded by Thomas Edison
only 2 years earlier, merged with its competitor Thomas–Houston Electric
Company. Over time, and as many other large successful firms in the
economy, the business of GE evolved, mostly prompted by savvy man-
agers who were able to anticipate future challenges. Over time, GE became
a highly diversified multinational business, operating in several different
sectors. The first stage of diversification came very early in the 20th cen-
tury. With the establishment of GE Labs, the pinnacle of scientific
research within a corporation at that time, the company expanded into
the manufacturing of transformers (1903), radio technology (1920s), and
12 For example, GE is the only firm of the original 12 companies that constituted the Dow Jones Industrial Index in 1896 still belonging to it. Moreover, when Irving Langmuir won the Nobel Prize in Chemistry in 1932, he became the first individual to receive such award for research performed outside an academic institution.
CESifo Economic Studies, 55, 3-4/2009 467
Executive Compensation over the 20th Century
silicone and nuclear power (1940s). The 1960s and 1970s were a period of diversification and GE was no exception, growing into sectors as diverse as aerospace, computers, and mining. As for many other firms becoming large conglomerates at that time, this fast growth came without significant improvements in stock market performance. Thus, the following two dec- ades saw a refocus of the corporate strategy, shifting from manufacturing to technology and (mainly financial) services, as well as increasing the presence of the company abroad. The company changed its focus again during the past decade, by diminishing the reliance on financial services and mature industrial businesses, expanding instead into healthcare and entertainment. By 2007, the financial unit, GE Capital, still accounted for about 42% of the firm’s profits. Deeply affected by the current financial crisis, the downturn in the unit has had severe consequences on the entire company, and the future economic health of GE is now uncertain.
3.2.2 Top management at GE and the specificity of skills
Table 1 provides information on the demographic characteristics of all presidents, chairman, and CEOs of GE since the firm’s inception. Over the many challenges faced throughout its history, only 12 top executives led GE. One of the main explanations for the trends in executive compensation is
a shift from specific to more general managerial skills. Educational and career background can plausibly inform on the types of skills of managers. Thus, Table 1 lists the educational degrees obtained by GE’s top man- agers. Up to the late 1950s, almost all of GE’s CEOs had a college edu- cation and had specialized in either engineering or law. Depending on this background, they had mainly worked their way up either in production or in the legal department before moving into general management. The education of GE’s top executives became more varied since the 1960s: in the past four decades, these individuals had degrees in economics, engi- neering, or mathematics. Moreover, Jeffrey Immelt is the first CEO at GE to hold an MBA degree, reflecting the growing importance of business education in the careers of top managers more generally. The educational and career background of GE’s top managers are indicative of a broader trend in the market for executives: top managers had their highest degree in engineering or general science up to the 1960s but the likelihood of degrees in finance and management have steadily increased since then (Frydman 2007). As revealed by the available biographical information, the work expe-
rience of top managers has also evolved considerably. Prior to the 1970s, most top managers worked mainly in one sector of the firm (as produc- tion, finance, or the legal department) throughout their entire career. Since then, a broader experience has become more important, perhaps because
468 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
T a b le
1 C h a ra ct er is ti cs
o f G E ’s
to p m a n a g er s:
d em
o g ra p h ic
a n d ed u ca ti o n a l ch a ra ct er is ti cs
N a m e
T o p ex ec u ti v e p o si ti o n
Y ea r o f b ir th
E d u ca ti o n a l b a ck g ro u n d
C h a rl es
A . C o ff in
P re si d en t
C h a ir m a n
1 8 4 4
E .W
. R ic e
P re si d en t
1 8 6 2
H ig h S ch o o l
G er a rd
S w o p e
P re si d en t
1 8 7 2
B S in
E le ct ri ca l E n g in ee ri n g , M IT
1 8 9 5
O w en
D . Y o u n g
C h a ir m a n
1 8 7 4
A B , S t.
L a u re n ce
U n iv er si ty , 1 8 9 4
L L B , B o st o n U n iv er si ty , 1 8 9 6
C h a rl es
E . W il so n
P re si d en t
1 8 8 6
O n -t h e- jo b tr a in in g ;
N ig h t co u rs es
P h il ip
D . R ee d
C h a ir m a n
1 8 9 9
B S in
E le ct ri ca l E n g in ee ri n g , U n iv er si ty
o f W is co n si n , 1 9 2 1
L L B , F o rd h a m
U n iv er si ty , 1 9 2 4
R a lp h J.
C o rd in er
P re si d en t
1 9 0 0
B S in
E co n o m ic s,
W h it m a n C o ll eg e,
1 9 2 2
C h a ir m a n a n d C E O
G er a ld
L . P h il li p p e
P re si d en t
1 9 0 9
B A
a n d M A , U n iv er si ty
o f N eb ra sk a , 1 9 3 2 a n d 1 9 3 3
C h a ir m a n
F re d J.
B o rc h
P re si d en t a n d C E O
1 9 1 0
B A
in E co n o m ic s,
C a se
W es te rn
R es er v e U n iv er si ty , 1 9 3 1
C h a ir m a n a n d C E O
R eg in a ld
H . Jo n es
C h a ir m a n a n d C E O
1 9 1 7
B S in
E co n o m ic s,
U n iv er si ty
o f P en n sy lv a n ia , 1 9 3 9
Jo h n F . W el ch
Jr .
C h a ir m a n a n d C E O
1 9 3 5
B S , U n iv er si ty
o f M a ss a ch u se tt s,
1 9 5 7 , M S a n d P h D ,
U n iv er si ty
o f Il li n o is , 1 9 6 0 , a ll d eg re es
in C h em
ic a l
E n g in ee ri n g
Je ff re y Im
m el t
C h a ir m a n a n d C E O
1 9 5 6
B A
A p p li ed
M a th , D a rt m o u th
C o ll eg e,
1 9 7 8
M B A , H a rv a rd
B u si n es s S ch o o l, 1 9 8 2
N o te : B io g ra p h ic a l in fo rm
a ti o n o b ta in ed
fr o m
th e B io g ra p h y R es o u rc e C en te r.
CESifo Economic Studies, 55, 3-4/2009 469
Executive Compensation over the 20th Century
T a b le
2 C h a ra ct er is ti cs
o f G E ’s
to p m a n a g er s:
ca re er
p a th , co m p en sa ti o n , a n d fi rm
’s m a rk et
v a lu e
N a m e
T o p ex ec u ti v e p o si ti o n
Y ea rs
a t p o si ti o n
Y ea r
jo in ed
fi rm
N u m b er
o f
y ea rs
in sa m p le
A v er a g e
to ta l re a l
p a y
G E ’s
a v er a g e
re a l m a rk et
v a lu e
C h a rl es
A . C o ff in
P re si d en t
1 8 9 2 – 1 9 1 2
C h a ir m a n
1 9 2 3 – 1 9 2 2
1 8 9 2
N A
N A
E .W
. R ic e
P re si d en t
1 9 2 3 – 1 9 2 2
1 8 9 2
N A
N A
G er a rd
S w o p e
P re si d en t
1 9 2 2 – 1 9 4 0 ; 1 9 4 2 – 1 9 4 5
1 9 1 9
2 0 .7 0 7
9 7 4 5 .1 0
O w en
D . Y o u n g
C h a ir m a n
1 9 2 2 – 1 9 4 0 ; 1 9 4 2 – 1 9 4 5
1 9 1 3
2 0 .6 8 2
9 7 4 5 .1 0
C h a rl es
E . W il so n
P re si d en t
1 9 4 0 – 1 9 4 2 ; 1 9 4 5 – 1 9 5 0
1 8 9 8
5 1 .4 8 7
9 1 5 7 .0 8
P h il ip
D . R ee d
C h a ir m a n
1 9 4 0 – 1 9 4 2 ; 1 9 4 5 – 1 9 5 8
1 9 2 6
1 4
0 .9 9 2
1 8 5 6 9 .6 5
R a lp h J.
C o rd in er
P re si d en t
1 9 5 0 – 1 9 5 8
C h a ir m a n a n d C E O
1 9 5 8 – 1 9 6 3
1 9 2 2
1 8
1 .2 4 2
2 4 3 1 9 .3 6
G er a ld
L . P h il li p p e
P re si d en t
1 9 6 1 – 1 9 6 3
C h a ir m a n
1 9 6 3 – 1 9 6 7
1 9 3 3
5 1 .5 8 2
4 3 0 8 2 .8 2
F re d J.
B o rc h
P re si d en t a n d C E O
1 9 6 3 – 1 9 6 7
C h a ir m a n a n d C E O
1 9 6 7 – 1 9 7 2
1 9 3 1
8 1 .7 9 0
4 3 9 6 0 .6 6
R eg in a ld
H . Jo n es
C h a ir m a n a n d C E O
1 9 7 2 – 1 9 8 1
1 9 3 9
8 2 .2 2 0
2 9 8 6 4 .3 3
Jo h n F . W el ch
Jr .
C h a ir m a n a n d C E O
1 9 8 1 – 2 0 0 1
1 9 6 0
2 2
1 9 .1 5 6
1 4 6 6 6 8 .9 0
Je ff re y Im
m el t
C h a ir m a n a n d C E O
2 0 0 1 – p re se n t
1 9 8 2
4 1 4 .4 9 1
3 1 4 6 0 2
N o te : B io g ra p h ic a l in fo rm
a ti o n o b ta in ed
fr o m
th e B io g ra p h y R es o u rc e C en te r. N u m b er
o f y ea rs
in sa m p le
re fe rs
to th e n u m b er
o f y ea rs
in w h ic h th e
ex ec u ti v e a p p ea rs
a m o n g th e th re e h ig h es t- p a id
m a n a g er s in
G E ’s
p ro x y st a te m en ts , fo r y ea rs
o f a v a il a b le
p ro x ie s.
T o ta l co m p en sa ti o n is
th e su m
o f
sa la ry , b o n u s,
lo n g -t er m
b o n u s,
a n d th e B la ck – S ch o le s v a lu e o f st o ck
o p ti o n s g ra n te d , d ef la te d b y th e C P I.
M a rk et
v a lu e in fo rm
a ti o n w a s o b ta in ed
fr o m
C R S P , a n d it is m ea su re d a t th e en d o f th e fi sc a l y ea r a n d d ef la te d b y th e C P I. B o th
co m p en sa ti o n a n d m a rk et
v a lu e in fo rm
a ti o n a re
in m il li o n
o f y ea r 2 0 0 0 d o ll a rs .
470 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
top managers are now required to lead corporations that are more diver- sified in nature. As a consequence, many firms established programs to rotate promising managers across different sectors. For example, Reginald H. Jones, GE’s CEO from 1972 to 1981, worked as a manager in con- sumer, utility, industrial, construction, and distribution fields after being assigned into general management, before becoming the chief financial officer of the corporation in 1968. Thus, he plausibly acquired skills in several different areas of the firm that contributed to his success as a chief executive of a widely diversified corporation. GE’s top executives were rising through the ranks of the company, as
displayed by their fairly long tenure: the shortest tenure of a chief execu- tive lasted 5 years while three CEOs remained at the position for at least 20 years. Excluding the early CEOs who joined the firm when it was founded, Jeff Immelt had the shortest tenure at the firm (a total of 18 years) among these nine individuals when he was appointed CEO in 2001 (see Table 2). At first pass, the evolution of managerial characteristics at GE reveals
somewhat conflicting evidence regarding the composition of skills of top managers. Both the change in educational background (from science and engineering to finance and management) and in functional experience (from working in one sector to rotating across different sectors) suggests that skills have become more general over time. In contrast, the long tenure at the firm could indicate that firm-specific skills are relevant. However, those top managers passed up for the chief executive position usually leave the firm to lead a company in, often, fairly different sectors. For example, when GE selected Jeff Immelt in 2001 for the CEO position, W. James Mc Nerney Jr. and Robert L. Nardelli, the two contenders from the firm that were passed up for the job, quickly left to become CEOs in firms as different from GE as 3M and Home Depot, respectively. The ability and willingness to move to a firm in different industry late in the career suggest that the skills of these top executives were mostly general. The evidence from GE suggests that change in the importance of skills
from firm specific to general occurred slowly over time. Thus, this theory does not seem to account for the sharp change in the level of compensa- tion for GE’s top managers that occurred in the 1970s, as described in Section 3.2.3.
3.2.3 Executive compensation at GE
A historical study in executive compensation is feasible for USA because the Securities and Exchange Commission has required publicly traded corporations to disclose the pay of the three highest paid officers since its inception in the 1930s. Using GE’s proxy statements, Figure 1 shows the trend in salaries and bonuses (either cash or stock, both awarded and paid out in the given year), as well as the evolution in total compensation
CESifo Economic Studies, 55, 3-4/2009 471
Executive Compensation over the 20th Century
(salaries and all bonuses plus the Black–Scholes value of stock option grants) for the three highest-paid officers. Because evidence for a single firm is intrinsically fairly noisy, the trends in pay are calculated using a 3- year moving average. Prior to the 1950s, the remuneration of GE’s top officers was entirely
composed of salaries and current bonuses prior to the 1950s. Perhaps prompted by extremely high labor income tax rates, forms of compensa- tion more directly tied to the performance of the firm started being used at mid-century. Since the 1950s, deferred bonuses tied to firm and, on occa- sion, to individual performance gained importance.
13 Perhaps more sur-
prising is that employee stock options became frequently used to remunerate ‘key employees’ over this period (see Figure 1). GE established its first stock option plan in 1953. Since high taxes on
labor income reduced the attractiveness of cash compensation, options had a considerable tax advantage since the 1950s. The 1950 Revenue Act determined that, when satisfying a series of qualifications, ‘restricted’ stock options could be taxed at the much lower rate on capital gains. Introducing the new plan, GE’s management argued to their shareholders;
Since [. . .] the Internal Revenue Code amendment in 1950 [. . .] over 200 companies whose stock is listed on the NYSE, including many compe- titors of your Company, have adopted stock option plans . . . [Such a plan] is essential if the Company is to compete successfully with other companies for the services of individuals of outstanding ability and accomplishment.
General Electric’ Proxy Statement, 20 March 1953
GE’s proxy statement suggests that, by helping the firm to get around prohibitive taxation, stock options allowed the firm to compete for man- agerial talent, although they accounted for a small fraction of total pay at that time (see Figure 1). More importantly, corporations were aware of its competitors’ compensation policies and, probably, of the level of remu- neration awarded to other top executives even during this period. Thus, the market for managers and, in particular, their compensation may have been more integrated during earlier decades than previously thought. The evolution of the total real level of pay for GE’s three highest-paid
executives indicates that there were two distinct periods in remuneration policies. First, the total real level of pay for GE’s top three managers
13 In the case of GE, these bonuses were mainly paid out after the executives had retired. However, many other large firms established incentive compensation plans that awarded bonuses to be paid out in cash or in stock over a number of years (Frydman and Saks 2009).
472 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
increased at a slow rate of about 2% per year from the 1940s to the 1960s. This period of little growth was followed by a rapid acceleration in top management pay, mostly encouraged by the increasing use of stock options since the 1980s and of restricted stock since the 1990s. From the 1970s to the present, the compensation of the three highest-paid officers at GE has grown at the significantly higher annual rate of 8%. These trends in pay are also evidenced when restricting the sample to Presidents, Chairmen, and CEOs. Table 2 shows the average pay for each of these top managers over the years in which they were listed in proxy statements. Compensation increased sharply for three chief executives who led the firm since the 1970s. Executive compensation behaved in a different manner in the past,
generating a different relationship between executive compensation and several of the proposed determinants for the recent increase in pay over
Figure 1 The real level of total executive compensation at GE.
Notes: Compensation is measured as the 3-year moving-average for each measure of pay for the three highest-paid executives as reported in GE’s proxy statements. Salary and Bonus are defined as the level of salaries and current bonuses both
awarded and paid out in the year. Long-Term (L-T) Bonus measures the amount paid out in the year from long-term bonuses awarded in prior years. Stock Option Grants is defined as the Black–Scholes value of stock options granted
in the given year. Total compensation is the sum of salary, bonus, long-term bonus, and the Black–Scholes value of stock options granted. The real level of pay is calculated in millions of $2000, using the CPI.
CESifo Economic Studies, 55, 3-4/2009 473
Executive Compensation over the 20th Century
the earlier decades. In particular, it is possible to analyze the relevance of
two main theories discussed in Section 2 in light of GE’s evidence. First, the long-run trends in pay do not appear to be driven by the
growth in aggregate firm size, as predicted by the theories on demand for talent and the scale of firms described in Section 2.1.1. Figure 2
shows that the level of total compensation for GE’s three highest-paid
executives was highly correlated with the S&P index since the 1980s. 14
However, this correlation was not present from the 1950s to the 1970s,
a period in which compensation increased at a slow pace through a rapid expansion and a significant contraction in the stock market.
15 Thus,
increasing size in the typical firm in the economy has not always been
reflected in higher compensation at GE. Another view is that corporate governance is a key determinant of com-
pensation. As described in Section 2.2.1, the sharp increase in compensa- tion could be explained if managers’ ability to extract rents increased, as
the firm’s corporate governance grew weaker. While measuring gover-
nance is intrinsically difficult, two proxies for governance can be con-
structed over time. Table 3 presents information on the size of the
board of directors and the fraction of directors that were insiders (officers of the firm in that year) in 1936, 1950, 1970, and 1990. Larger boards have
been linked to less effective monitoring, since in this case the CEO could
be more prone to influencing the directors’ decisions (Jensen 1993,
Yermack 1996). A high fraction of insiders may indicate poor governance
as insiders may weaken the monitoring abilities of a board if they are more loyal to the CEO. On the other hand, inside directors may have more
information about the workings of the firm. In the context of GE, top
executives were awarded both high and low levels of pay in periods of
large board size. Moreover, the composition of the board of directors
remained fairly stable since the 1950s while compensation changed dramatically. An alternative mechanism for control and monitoring is the presence of
large blockholders. If the growth in pay is related to weak governance, the
concentration of ownership could reduce CEOs ability to extract rents by
providing direct monitoring. On the other hand, large blockholders may
14 To be consistent with the trends in compensation, the S&P index is also calculated as a 3-year moving average.
15 The theory on increasing returns to firm scale implies that the evolution in compensation over time should be determined by the size of the typical firm in the economy. I approx- imate the typical firm using the S&P index, but similar results would be obtained using the market value of a sizable sample of large firms, as the S&P 500 or all firms in ExecuComp. Except for a smaller increase during the 1950s and 1960s, the evolution of market value for GE followed a similar pattern than the S&P index.
474 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
lead to hire pay if improvements in monitoring lead to a higher likelihood
of being fired, as discussed in Section 2.2.2. Neither of these mechanisms
applied to GE. While systematic long-run evidence on firm ownership is
not available, information from the 1930s and the 1990s reveals that GE
did not have a large blockholder (measured as an individual or institution
owning at least 5% of the shares outstanding). Ever since its inception, the
ownership of GE has been fairly dispersed.
Figure 2 Real total executive compensation at GE and the S&P Index. Notes: Compensation and the S&P index are measured as a 3-year moving-
average. Total compensation is the sum of salary, bonus, long-term bonus, and the Black–Scholes value of stock options granted the three highest-paid executives as reported in GE’s proxy statements. The real level of pay is calcu-
lated in millions of $2000, using the CPI. The S&P index is also expressed rel- ative to the CPI and equals 1 in 2000.
Table 3 Board size and board composition
Year Board size Fraction of inside directors
1935 19 31.58 1950 17 11.76
1970 12 16.67 1990 18 11.11
Note: Board size and composition was obtained from the corresponding volumes of
Moody’s Manual of Investments. Inside directors are identified as the members of the
board that are also listed as officers of the firm in Moody’s.
CESifo Economic Studies, 55, 3-4/2009 475
Executive Compensation over the 20th Century
Thus, according to these different measures, there is no evidence that
changes in corporate governance at GE relate to the evolution of compen-
sation at the firm. The historical evidence indicates that corporate gover- nance, increasing returns to scale in a competitive labor market, and
changes in managerial skill types cannot account for the changes in top
executive compensation at GE over the longer run.
3.2.4 Representativeness and generalization of the findings
Focusing on a particular company allows revealing both general trends as
well as emphasizing that the experiences of particular firms and managers
are, to a large extent, idiosyncratic. However, it is important to relate the
evidence for GE to more general, stylized facts on compensation and managerial careers that have been put forth by the existing literature.
Moreover, new long-run facts can be used to illuminate the current
debate on the drivers of executive pay. While GE is only one and a particularly successful firm, the trends in
compensation described for its three highest-paid officers match closely
the more general trends uncovered in the literature. Using a more com- prehensive set of firms, Frydman and Saks (2009) show that the pattern in
executive pay changed substantially over time. Following World War II,
executive pay remained fairly constant for almost three decades. This is
surprising relative to current evidence because the governance of corpora-
tions was arguably weaker, the ownership of firms was more dispersed than in recent years, and firms were also growing and becoming more
complex during this earlier period. Thus aggregate data as well as GE’s
information suggest that returns to scale and corporate governance cannot
on its own account for the long-run changes in compensation. In contrast to other firms, GE did not experience much change in its
governance or ownership structure, but its size and complexity grew at par with other large successful firms. Moreover, anecdotal evidence from GE
and other corporations suggests that firms were aware of and took the
compensation strategies of competitors into account when determining the
pay of their top managers, at least since the disclosure of pay data started
being required by the SEC in the 1930s. Thus, it is unlikely that the growth in CEO pay in the past three decades was triggered by a sudden ratcheting
effect induced by compensation consultants. It is difficult to argue that the competition in product markets did not
increase as well during the 1950s and 1960s, a period of little change in
executive compensation for GE and for other firms in the economy. However, trade and globalization may have affected firms at the end
of this period in a different manner, by altering the tasks that executives
were responsible for and, consequently, the market for managers
476 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
more broadly. 16
The history of GE is indicative of an important transfor- mation in the market for top managers. Once large corporations were relatively mature by the 1950s and 1960s, the market for top managerial talent took place mostly within the organization. These ‘organization men’ rose through the ranks of the firm, most often than not working their way up in one particular area of the firm (usually in production or in the legal department) (Whyte 1956). Managerial skills seem to have been mostly firm-specific; top executives usually had an educational background in science or engineering, were exposed to a single area of the firm before becoming general managers, spent most of their career at the same cor- poration, and rarely moved to a different firm late in their career (even when passed up for the chief executive position). The characteristics of GE’s top managers discussed in Section 3.2.2 fit perfectly with this general description. The slow but steady growth in the importance of business education and
the increasing diverse sectoral experience of managers in the economy indicate that managerial skills have become more general in nature since mid-century. While the skills of GE’s top managers have also become more general in nature, a difference relative to the overall market is that GE maintains a policy of forming and recruiting its own top managerial talent within the organization. All of GE’s top executives have come from within the firm, had a long tenure before reaching the CEO position and, thus far, have not been fired. This contrasts sharply with the evidence for the overall market for managers. As discussed in Section 2.1.2, the likeli- hood of selecting an outsider for the CEO position has more than doubled in the past three decades. But perhaps this difference is somewhat endo- genous, as GE has a reputation for being one of the best producers of corporate leaders. Selecting the CEO from within the organization does not necessarily
imply that the skills of the managers are firm specific. In fact, the behavior of the market for managers indicates that the mobility of executives across industries and organizations has increased, as top managers passed up for the CEO position in corporations selecting insiders as chief executives are often poached by other firms. The responsibilities of top executives appear
16 Anecdotal evidence suggests that a shift in the demand for managerial skills occurred as firms evolved during the 1950s and 1960s due to globalization, competition, and increases in the complexity of large corporations. For example, Packard (1962) empha- sizes that ‘‘Both the competition and the new markets that European unity promises— plus the need of US companies to expand significantly to develop world markets—call for new imaginative kinds of business leadership. [. . .] There is grave doubt that America industry has been developing enough of the kind of leaders who will be competent to guide their enterprises effectively in this new environment.’’
CESifo Economic Studies, 55, 3-4/2009 477
Executive Compensation over the 20th Century
to have evolved over time, arguably from tasks requiring mostly firm-
specific skills to decisions based on general human capital that could be
applied in diverse firms. However, the pace and magnitude of these
changes (both at GE and in the economy) suggest a relatively minor
role of a shift in the types of managerial skills on the long-run evolution
in compensation (Kaplan and Rauh 2009, Gabaix and Landier 2008). In sum, GE has been one of the best performers throughout the entire
20th century, but the trends in the level and structure of compensation for
its top executives and the characteristics of its managers are fairly repre-
sentative of most large publicly traded corporations. Earlier data provides
a new environment to contrast the main theories for the recent rise in CEO
pay. 17
Available evidence suggests that the proposed explanations do not
fit well with the long-run trends, raising new challenges to provide an
understanding of the evolution of executive compensation and the labor
market for corporate managers.
4 Conclusion
In this article, I argue that the lack of consensus on the determinants for
the recent increase in CEO and other top management pay is in part
associated with the use of quantitative evidence that is limited to the
past three decades. Because the changes in compensation have been
fairly monotonic over this period, an understanding of the time-series
evolution of pay has been limited. An alternative strategy to better grasp the mechanisms that affect exec-
utive compensation is to learn from the past by assessing the main pro-
posed theories using data for other countries or other time periods. In
particular, the disclosure of compensation for publicly traded corpora-
tions allows this exercise for US firms since the 1930s. These historical
data reveal a complex picture of the evolution of managerial pay and the
market for managers. Moreover, most of the common explanations for the
recent changes in compensation cannot individually account for its evo-
lution over the long run. To match the trends suggested by the quantita-
tive and anecdotal evidence for the 20th century, future research should
evaluate new views of the determinants of pay as well as address how the
relevant explanations have changed over time.
17 Two remaining theories, the importance of social norms and outside opportunities for managers, are hard to assess empirically because it difficult to construct relevant proxies.
478 CESifo Economic Studies, 55, 3-4/2009
C. Frydman
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