Explaining The International CEO Pay Gap: Board Capture Or Market Driven?

Abstract

If we look at convergence through the lens of the Risk Adjustment Theory, then international pay convergence will only occur if U.S. and foreign CEOs' firm-specific risk levels converge. Empirically, this is a difficult claim to test because of the paucity of data available on CEOs' individual wealth levels and stockholdings. The one component we can most easily observe, stock option usage, is presently quite different, with U.S. levels far exceeding those abroad. For the near future, this trend seems likely to continue, making it difficult to forecast convergence any time soon. The international executive pay gap is one of the great puzzles of executive compensation. In this paper, I have argued that the divergence between American and foreign CEO pay can be explained by a variety of market-based theories. I claim that such theories cast more light on the persistence of these wage gaps than sole reliance on board capture claims. Does the international pay gap constitute a crisis in corporate governance that requires government intervention? No. For one thing, international pay levels are largely determined by underlying economic forces, such as the marginal revenue product of executives, the difference in alternative job prospects, and the relatively larger size of American firms. These factors are dictated by markets and will adjust as markets adjust. The pay gap will disappear if these conditions move toward convergence. Even if the pay gap is partially explained by differences in the relative bargaining power of American executives, it is unclear whether such differences arise from Board Capture or the Bargaining Power Theory. Which one is right leads to very different policy implications.