The Determinants of Executive Salaries: An Econometric Survey

FOR over three decades, debate has raged over the economic assumption that the large corporation, through the decisions of its managers, attempts to maximize its profits. Empirical analysis of the behavior of the corporation has led to conflicting claims. The inquiry into the determinants of executive compensation has been no exception. Statistical investigation of executive compensation has been dominated by a search for one decisive explanation. Is the size, measured by either sales or assets, or profitability, measured by net corporate income or by the rate of return on assets, the key variable in establishing the level of the executive's reward? Proponents on both sides of this issue-the managerialists who support the corporate growth hypothesis and the neoclassical economists who favor the profit maximization assumption-seem to argue that the contest can be resolved by the presentation of unambiguous evidence that will award victory to one side and vanquish the other. This spirit of antagonism has distorted the essential element of the executive compensation question. The behavior of the corporation and the market forces that shape this behavior can be explained or illustrated only by the use of a series of intercorrelated variables. Not one of the available measures of corporate success, be it net income, sales or assets, is an exact measure of economic profits or firm size, nor is it independent of the other variables. This study focuses on the resolution of the serious econometric problems encountered in the process of estimating the determinants of executive compensation. Later we will show how the successful elimination of problems of simultaneous equations bias, multicollinearity and heteroscedasticity leads to the conclusion that the managerialist and neoclassical models of the firm are complementary, rather than substitute, explanations for the pattern of executive compensation.