«Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. Executive ...»
Table 1 reports basic descriptive statistics of our main sample, which includes the three highest-paid officers in each firm.7 There are more than 15,800 executive-year observations between the years 1936 to 2005, for a total of 2,862 individuals. The job titles held by the executives in our sample suggest that these officers were the main decision-makers in the firm (see Table 2). More than 47 percent of these managers held the title “CEO,” “president,” or “chairman of the board.”8 Furthermore, more than 80 percent of these officers also served on the board of directors.
3. Long-Run Trends in Compensation
3.1 Trends in total compensation Although we collected data on the five highest-paid officers in each firm whenever possible, corporate reports consistently listed only the three highest-paid officers prior to 1978. We limit our analysis to the top three officers in order to maintain a consistent group of individuals over time, but the results are robust to including the 4th and 5th highest-paid executives.
Restricting the analysis to CEOs is useful for comparing our sample to previous research, which has mainly focused on chief executive officers. Because the term “CEO” was not frequently used until the 1970s, identifying who held this title is not always straightforward. Previous studies suggest that this person was most often the president of the company, so we identify the president as the chief executive where the CEO is not explicitly mentioned (Mace 1971). In cases where we observe neither a CEO nor a president, we identify the chairman of the board as the CEO (about 2 percent of the observations).
Figure 1 shows the median real value of total compensation from 1936 to 2005.9 We define total compensation as the sum of salaries, bonuses, long-term incentive payments, and the BlackScholes value of stock option grants. The figure reveals three distinct phases that form a Jshaped pattern over the course of our sample period. During the first 15 years, the real value of compensation fell from about $0.9 million to $0.75 million. Although more pronounced during World War II, the decline in executive pay continued from the end of the war until the early 1950s. This period of deterioration was followed by 25 years of slow growth, averaging 0.8 percent per year from 1950 to 1975. Finally, the level of executive pay has climbed at an increasing rate since the mid-1970s. Although compensation dipped briefly from 2001 to 2003, it resumed a rapid rate of growth during the last two years of our sample. Thus, the rapid increase in pay in the 1990s did not end with the collapse of the stock market boom in 2000.
More than 95 percent of the individuals in our sample fall above the 99.9th percentile of the national distribution of wage and salary income documented by Piketty and Saez (2003).
Therefore, a comparison of executive pay to the earnings of a typical worker provides insight into the evolution of earnings inequality at the top of the income distribution. We calculate relative executive pay by dividing median compensation in our sample by average earnings per full-time equivalent worker from the National Income and Product Accounts.
This measure of earnings inequality follows an even-more pronounced J-shaped pattern over our sample period than the dollar value of executive pay (see the dashed line in Figure 1).
The real value of average earnings in the economy increased during the early years of our sample even as the level of executive pay declined, leading to a sharp contraction in the gap between these two groups from 1940 to 1944. Relative executive pay declined further until 1970, at which point executive earnings began to rise faster than those of the average worker. By 1990, Throughout the paper, real values are measured in year 2000 dollars using the Consumer Price Index.
relative executive pay had recovered its Depression-era level. The gap between executives and workers expanded even further during the most recent 15 years, and by 2005 the median executive in our sample earned 110 times average worker earnings—about twice the corresponding ratio prior to World War II. Despite differences in the underlying source data between our sample and the income tax records used by Piketty and Saez to calculate wage and income shares, the trend in relative executive pay is similar to the share of the top 0.1 percent of the national distribution of wage and salary income.10
3.2 The structure of executive compensation Figure 2 decomposes the real value of total compensation into its three main components. The short dashed line shows the median value of salaries plus any bonus that was both awarded and paid out within the same year, which we refer to as a current bonus.11 These bonuses were generally paid in cash, but some were also paid in company stock. The long-dashed line adds the amount paid to each executive as part of a deferred bonus or long-term incentive payment.12 The solid line, which replicates the real value of total compensation shown in Figure 1, adds the Black-Scholes value of stock option grants.
Piketty and Saez use income tax records to estimate shares of aggregate wage and salary income. One disadvantage of income tax data is that they only contain information on the gains from exercising options. We use the value of stock option grants, which reflects the value of pay at the time of the award more accurately, and are not affected by subsequent movements in the firm’s share price or by the executive’s decision when to exercise the options. Moreover, the vast majority of employee stock options during the 1950s and 1960s were taxed as capital gains, and so would not have been reported on income tax returns as wages and salaries. Rather, they would have appeared as capital gains, but only upon the sale of the stock that had been purchased when the option was exercised.
Although it would be useful to separate salaries from current bonus payments, many firms reported only the sum of the two prior to 1992. In firms that did report these payments separately between 1947 and 1991 (about 20 percent of the sample in these years), the value of current bonus payments usually ranged between 20 and 45 percent of current pay, with no obvious trend. Therefore, grants of current bonuses do not appear to have followed the same upward trend as the use of long-term pay (discussed below).
We measure bonuses as the amount received during the year rather than the amount awarded (to be paid in the future) for consistency, because Compustat and some earlier proxy statements do not report information on the value of bonuses awarded.
During the first twenty years of our sample, compensation was composed mainly of salaries and current bonuses. Although long-term bonuses were awarded to some executives as early as the 1940s, they were not common enough to make a noticeable impact on median pay until the 1960s.13 These long-term bonuses were usually based on the firm’s profits or net income, with payment in cash or stock distributed in equal installments over a certain number of years.14 These bonuses became a greater share of compensation over time, reaching more than 35 percent of total pay by 2005.
Stock option grants have also become a larger fraction of compensation over the course of our sample period. Among executives receiving an option award, the median value of grants fluctuated between 15 and 30 percent of total compensation from the mid-1950s to the mids. The upper end of this range is not much less than the median value of 37 percent during the option boom of the late 1990s, suggesting that options have been an important component of executive pay since mid-century.15 Because the value of an option award relative to the total pay of those executives being granted options has not risen greatly over time, the increasing importance of stock options relative to median total compensation is largely due to an upward trend in the frequency of grants. The use of employee stock options was almost negligible during the 1930s and 1940s. In 1950, tax reform legislation introduced the restricted stock option, a special type of option that was taxed as a capital gain instead of as labor income. Consequently, executives paid a marginal The 1950s were not the first period when incentive compensation mechanisms were a part of managerial pay.
Historical accounts suggest that both current and deferred forms of incentive compensation were almost negligible prior to WWI but became commonly used during the 1920s (Taussig and Barker 1925, Baker and Crum 1935, Baker 1938, Roberts 1959). With the onset of the Depression and large declines in firm profits, many bonus plans were abandoned or suspended (Baker 1938).
The deferral period was generally around 5 years, although individual plans varied from 2 to 10 years.
The popular press also highlighted the significance of options as a form of executive remuneration during this earlier period, with headlines such as “Option Opulence” (Wall Street Journal, Feb. 1 1955) and “Stock Options Popular” (New York Times, Mar. 26, 1958).
tax rate on these options of only 25 percent instead of the 70 to 90 percent marginal rate they faced on labor income. More than 40 percent of the firms in our sample instituted a restricted stock option plan in the 5 years following this reform, suggesting that this tax policy had a significant impact on executive pay.
Despite the proliferation of restricted stock option plans during this period, the awards made under these plans were sporadic at first. Throughout the 1950s, only about 16 percent of the executives in our sample were awarded an option in any given year. The frequency of stock option grants has increased steadily since then. By the 1990s, the fraction of executives receiving an option had reached 82 percent (see Figure 3).
Prior research on executive pay has found more infrequent option use during the 1970s and the early 1980s than we find in our sample (Hall and Liebman 1998, Jensen and Murphy 2004, and Murphy 1999).16 The difference between our results and prior research can be partly explained by firm size. Our sample is more heavily weighted towards large firms than other samples, and large firms tend to grant options more frequently. However, several measurement issues are also important in explaining these discrepancies. First, prior work on option use in the 1970s has relied on data on the gains from exercising options rather than direct evidence on option grants. In our data, the probability of being granted an option during the 1970s was 16 percentage points higher than the probability of exercising an option, possibly due to poor stock market performance during this period.17 The high frequency of stock option grants in our sample is also related to the treatment of multi-year reporting of options. Many proxy statements There is little evidence in prior research on the use of employee stock options prior to the 1970s. Lewellen (1968) provides a notable exception for the period 1940 to 1963. Although he claims that stock options were a much more important share of executive pay than our data suggest, his method of valuing options is substantially different from ours and is likely biased upward. See Section 3.2 of the Appendix for details.
The downturn in the market made the repricing of options a common practice during the 1970s. We exclude repriced options from our estimates of grants whenever it is possible to identify them.
issued from the late 1960s to the late 1980s reported option grants and exercises as 3- or 5-year cumulative totals, making it difficult to ascertain the actual number granted or exercised in each year. While our treatment of multi-year reporting biases the frequency of grants upwards, the average and median values of options granted are unbiased. See Sections 2.2 and 3.2 of the Appendix for further details.
3.3 Other forms of compensation Our analysis does not include information on two other components of pay: pensions and perquisites. Although proxy statements provide descriptions of pension plans, we are unable to estimate the value of these benefits because many plans were based on an age-tenure profile of the managers and we lack this information on most of the managers in our sample. We exclude perquisites because firms were not required to report any information on this type of pay until the late 1970s.18 The omission of pensions and perks may bias our estimate of the trend in total compensation because they are not subject to personal income taxes at the time they are awarded, so these methods of pay may have been more common in the 1950s and 1960s when tax rates were particularly high. Thus, the growth rate in total pay (including both observed and unobserved forms of compensation) may have been faster during these earlier decades than in later years when the tax advantage of pensions, perks, and other non-taxable benefits was smaller.
Regulation introduced in 1978 required firms to disclose the total amount of remuneration distributed or accrued in the form of securities or property, insurance benefits or reimbursement, and personal benefits. Perquisites and other personal benefits (above a minimum threshold) have been separately reported since 1993. However, the accuracy of data on perks is limited, and so most research has focused on whether a certain perk was offered rather than on its actual value (Rajan and Wulf 2006, Yermack 2006) On the other hand, evidence from Lewellen (1968) suggests that pensions cannot account for the low rate of growth in executive compensation observed during the 1950s and 1960s. He reports that the after-tax value of retirement benefits was 15 percent of after-tax total pay from 1950 to 1963. Because pensions were taxed at a lower rate than cash compensation, the pre-tax value of pensions relative to total pay was even lower than 15 percent. By contrast, Sundaram and Yermack (2006) find increases in the actuarial value of pensions to be about 10 percent of total CEO pay from 1996 to 2002, and Bebchuk and Jackson (2005) report a ratio of executives’ retirement benefits to total pay received during their entire service as CEO of about 34 percent in
2004. Thus, pensions do not appear to have been a larger fraction of total compensation in the 1950s or 1960s than they are today.