It found that CEO pay in the United States to be about 1.3 times that of CEOs in the UK and argued that a significant portion of the greater U.S. CEO pay could be attributed to the higher proportion of equity-based pay, such as stock options, in the United States, and the higher risk premiums associated with such pay. The Economics of Executive Pay

High and rising executive pay could be a cause for policy concern on efficiency grounds or on equity grounds. Current pay levels would be economically inefficient if they resulted from a market failure that prevented pay levels from reflecting an equilibrium between supply and demand in the labor market for executives. Some economists argue that the trend in executive pay is not just an equity issue, it is the result of market imperfections that allow executives to manipulate the market outcome. It could also be that the increase in pay is driven by a relative increase in the demand for executives. But does the board really represent the shareholders' interests? Since executives at competing firms are also overpaid, the firm's performance would not fall behind its competitors. Board "Capture"

The neo-classical model assumes that executive pay is determined through "arm's length contracting": in negotiating the executive's pay, the board of directors (typically through its compensation committee) is charged with driving the best bargain it can obtain on behalf of shareholders. "Golden parachutes," generous severance or retirement packages (details of which do not have to be disclosed beforehand), "golden hellos" (additional incentives to join a company), life insurance, deferred compensation, personal loans (before the Sarbanes-Oxley Act), bonuses that are not linked to company performance, and company-provided perks in the form of vehicles, aircraft, and club memberships are all examples of stealth compensation. From a neo-classical perspective, it is difficult to understand why stock options are awarded rather than stock—when the options are too far "underwater" (the stock price is below the option's strike price), there is no incentive effect, and when it is close to the strike price, executives may be extremely risk averse for fear that the option will fall below the strike price. In the context of this report, this shift to so-called "performance-based" pay turns out to be important because it was the source of most of the rise in executive pay in the 1990s and 2000s. BF identify several common characteristics of stock options that seem inconsistent with the pay for performance mantra. Stock options are almost always designed to reward absolute performance rather than relative performance. Yet boards have become more independent and active in recent years. From an economic perspective, the starting point for determining whether pay is excessive is likely to be whether or not pay exceeds marginal product. They fall under three broad categories: improving the transparency of executive pay, strengthening board independence to reduce the potential for board capture, and strengthening shareholder control over the board and management. Factors that may have played a larger role in the growth of stock options include the bull market of the 1990s, not having to treat stock options as a corporate expense, and pressure on firms to provide executive pay that better aligned their interests with those of shareholders. A Cap on the Deductibility of Executive Pay When It Exceeds a Certain Ratio of Non-Managerial Pay

Some critics of executive pay have advocated changing Section 162(m) of the Internal Revenue Code to prohibit businesses from taking tax deductions for compensation provided to executives when the ratio of executive pay to that of its employees exceeds a certain level. In July 2007, the SEC proposed two quite divergent policy proposals. The managerial power critique has fueled growing interest in giving shareholders a non-binding vote on individual executive pay packages. 1257 ), which was approved by the House on April 19, 2007, and Obama's companion and identically named bill ( S. 1181 ).
In the past ten years, the pay of chief executive officers (CEOs) has more than doubled, and the ratio of median CEO to worker pay has risen to 179 to 1. High and rising executive pay could be an issue of public concern on two different grounds. First, it is contributing to widening income inequality that may be of concern from an equity perspective. Second, it could be the result of economically inefficient labor markets. It is difficult to determine whether executive pay is excessive across the board since executives' marginal product cannot be directly observed. An upward trend in pay over time is not sufficient proof that the market is not efficient since factors determining supply and demand, such as the skills required of the position, can change over time. To show that pay is excessive from an economic perspective, one must first demonstrate that there is a market failure that is preventing the market from functioning efficiently. The market failure could originate in the division in large modern firms between management and ownership, which is typically dispersed among millions of shareholders. Shareholders' interests are represented by a board of directors. Critics of executive pay have argued that boards have all too often been "captured" by the executive and are no longer negotiating pay packages that are in the shareholders' best interests. They point to a number of common practices that they call "stealth compensation" which are inconsistent with arm's length contracting. These include "golden parachutes," generous severance packages, company-provided perks, and bonuses that are unrelated to firm performance.
Stock options have been the fastest growing portion of executive pay since the 1990s, and critics believe this pattern can also be explained through the prism of stealth compensation. Rewarding executives with employee stock options was often justified in terms of the "pay for performance" mantra, but options are usually designed to reward absolute, not relative, performance. This means that in the bull market of the 1990s, when virtually all stock prices were rising, a company could fall behind its competitors and its executives could still receive handsome options payouts. Indeed, a sizeable portion of the increase in executive pay in the 1990s was likely due to options that turned out to be much more valuable than expected because of the unprecedented price increases of the bull market.
Many of the recent corporate scandals appear consistent with stealth compensation as well. Stock options backdating, earnings manipulation, and accounting fraud might have been motivated by attempts to covertly increase executive pay. If short-term fluctuations in the stock price are not good proxies of firm performance, then tying compensation to the stock price can create incentives for executives to engage in activities that are detrimental to shareholders. Policy proposals mostly focus on improving transparency, increasing board independence, and strengthening shareholder control rather than attempting to curb pay directly. S. 1181 (Obama) and H.R. 1257 (Frank), which the House approved on April 19, 2007, would give shareholders a non-binding vote on executive pay. Another proposal would modify the limit on deductibility of executive pay from corporate taxation. More broadly, income inequality could be reduced by increasing the progressivity of the tax system. For current developments and legislation, see CRS Report RS22604, Excessive CEO Pay: Background and Policy Approaches.