Executive Pay: Regulation vs. Market Competition

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The economic slowdown and the active politicalseason are generating calls for imposing newregulations on executive pay. The presidential candidatesof the two major parties have lashed out atwhat they perceive to be excessive pay for certainexecutives or for corporate executives in general.

Such populist sentiments are often based onmisunderstandings about the role of corporateexecutives in the economy and the vigorous competitionthat exists for these highly skilled leaders.In the past, federal regulatory efforts basedon such misunderstandings have generatedunintended consequences, which have damagedthe economy and hurt the ability of the marketfor executives to self-regulate over time.

The labor market for executives and the associatedpay levels are already subject to high levelsof regulation. Indeed, U.S. corporations are subjectto more stringent executive pay disclosurerequirements than corporations anywhere else inthe world. Before additional regulatory and legislativeefforts are unleashed, policymakersshould examine the rationale for current paystructures and the strong links between executivepay and corporate performance.

The misperceptions that drive regulatory effortsare grounded in the idea that the market for executivesis not competitive and that pay levels do notreflect supply and demand for talent. Critics claimthat executives essentially set their own pay throughtheir influence over the boards of directors of corporations.This "myth of managerial power" leadssome policy makers to conclude that greater governmentregulation is necessary because the marketis "rigged." However, a large body of empiricalresearch documents that labor markets for executivesare indeed competitive, and that pay levelstrack corporate performance.

This study examines the market forces that setthe parameters of executive compensation, theprocess that boards use to determine pay packages,and the data that indicate the efficient workingsof the current "pay-for-performance" model.It also discusses the adverse consequences ofimposing rules and regulations on an executivecompensation system that has helped to generategreat wealth for shareholders and millions of jobsfor American workers.

Ira T. Kay and Steven Van Putten

Ira T. Kay is global practice director of executive compensation consulting at Watson Wyatt Worldwide. Steven Van Putten is a practice leader of Watson Wyatt's executive compensation consulting practice.