CEO Compensation and the Tournament Theory: An Empirical Analysis of Recent Data.
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With its increase of 571% between 1990 and 2000, chief executive officer compensation has become a topic of vigorous debate both in the media and in economics. One approach to CEO pay is the tournament theory, introduced in 1981 by Lazear and Rosen. It provides an economic explanation of the promotion process and offers a scheme for an efficient corporate structure. Several economists have tested whether companies determine the compensation of their employees according to the model, using data mostly from before 1990. Back then stock options were not a significant part of CEO pay, but this type of compensation has gradually become the largest portion of executive pay. Therefore, in my study I include the present value of stock options granted annually as a part of the package. The purpose of my research is to test whether CEO compensation is consistent with the tournament model and to determine the role of stock options in this scheme. I use data from 2003 for 77 companies, all ranking in the top 100 biggest companies in the United States. I collected personal data on the CEOs, on the companies and on the compensation of the five highest paid officers. I ran regression analyses on the effect of personal and firm characteristics on CEO pay and on the pay gap between CEO pay and average vice president pay. I also tested the association between the number of contestants for the CEO prize and the prize they are competing for. By conducting these tests, with stock options included and not included, I could observe the effect of stock options on the results.