The most visible and highly paid person in most corporations is the chief executive officer (CEO). CEO compensation is particularly important to firms for three reasons. First, the compensation package is likely to be important in attracting and retaining good CEOs. Second, the form of the pay contract is likely to help determine whether the CEO focuses on value maximization or some other objective. Third, employees throughout the organization carefully follow their CEO's pay. Important morale problems can occur when employees think that the CEO is overpaid. For instance, employees complain bitterly when they are asked to take pay cuts because the company is in trouble, yet at the same time the CEO gets a big raise.

Controversy over CEO pay has increased substantially in recent years. One charge is that the level of CEO pay is too high. CEO pay is so huge that people don't believe they deserve it. It is easy to point to many CEOs who report compensation in the millions of dollars (reported compensation figures typically include salary and bonus payments, as well as the expected value of stock option and restricted stock grants). Consider the following two examples. Investors were outraged when the giant Swiss drug company Novartis gave its departing chairman, Daniel Vasella, $78 million as part of a non-compete contract, whereby Vasella would keep collecting his annual salary so long as he didn't go work for a competitor. After this turned into a giant PR disaster, Vasella and the board called the whole thing off. In 2009, Hewlett-Packard laid off 6,400 workers but paid its CEO Mark Hurd $24.2 million. In 1980, CEO compensation was 42 times that of the average worker. In 2013, it was 331 times.

The second major criticism of CEO pay concerns how CEOs are paid. Critics argue that CEOs are agents of stockholders and that CEO pay should be based heavily on stock-price performance. In some celebrated cases CEO pay appears disconnected to CEO performance. For example, the CEO of the health care provider McKesson not only earned $145 million in 2013 but also received an employment agreement containing an eye-popping $469 million severance payout should he be terminated. The CEO of General Growth Properties received compensation of $66.7 million even though the firm spent most of 2010 in bankruptcy.

From 1980, the increasing use of stock options and restricted stock grants has boosted the sensitivity of the average CEO's wealth to firm performance. However, the absolute sensitivity of CEO wealth to performance remains small. Research indicates that for a $1,000 change in firm value, the wealth of the average CEO of a large public corporation changes by under $10 (depending on the year and estimation method). Some argue this relation (which is equivalent to the CEO owning less than 1 percent of the common stock) is too small and that most companies would be better off if they increased incentive pay for CEOs. Some support for this view seems to come from studies that document an increase in stock price when companies announce that they are increasing incentive pay for CEOs.
1. Do you think the fact that most American CEOs are paid so much more than rank-and file employees suggests CEOs are overpaid? Explain.
2. Japanese CEOs generally receive much lower levels of compensation than CEOs in the United States. Does this imply that U.S. CEOs are overpaid?
3. Is it obvious that $10 per thousand is too low of an incentive pay for CEOs? Explain.
4. Does the observation that the stock price increases when firms increase incentive pay for CEOs suggest that most CEOs do not receive enough incentive compensation? Explain.
5. Are there any reasons why overpaying CEOs might be in the shareholders' interest (i.e., maximize shareholder value)?