Executive compensation and matching in the CEO labor market

This study examines the matching of CEOs to firms and the compensation earned by such managers in a competitive labor market. I first develop a simple competitive equilibrium model and derive predictions regarding the change in wages when an inelastic supply of CEO labor cannot match an increase in demand. The model predicts that the CEO pay-size elasticity increases when more firms compete for a fixed supply of managers. I then empirically test this prediction using industry-level IPO waves as a proxy for increased competition among firms for CEOs. Consistent with the model, I find that pay-size elasticity increases with an increase in an industry's IPO activity. I also find that increased IPO activity leads to a greater likelihood of executive transitions between firms. Overall, the findings point to the substantial role market forces play in the determination of pay in the CEO labor market. I then use a structural model to examine the distortionary effects of frictions in the CEO labor market. I estimate the switching cost to be 20% of the median firm's annual earnings. While reduced-form estimates of the switching cost serve as a lower bound on the reduction in firm value, they underestimate the overall effect which also includes the resulting inefficient firm-CEO matches. Using counterfactual analysis, the switching cost is estimated to decrease the median firm's value by 4.8%, four times larger than the reduced-form estimate.