Why are executives paid so much, and how it's all Gretchen's fault

Kevin J. Murphy and Jan Zaojnik have an interesting take on rising executive pay that challenges Bebchuk's thesis that it's all about managerial power.  In Managerial Capital and the Market for CEOs Murphy and Zaojnik argue:

This paper reconciles three pronounced trends in U.S. corporate governance: the increase in pay levels for top executives, the increasing prevalence of appointing CEOs through external hiring rather than internal promotions, and the increased prevalence of hiring outside CEOs with prior experience as CEOs. We propose that these trends reflect a shift in the relative importance of "managerial ability" (CEO skills transferable across companies) and "firm-specific human capital" (valuable only within the organization). We show that if the supply of workers in the corporate sector is relatively elastic, an increase in the relative importance of managerial ability leads to fewer promotions, more external hires, and an increase in equilibrium average wages for CEOs. We test our model using CEO pay and turnover data from 1970 to 2000. We show that CEO compensation is higher for CEOs hired from outside their firm, and for CEOs in industries where outside hiring is prevalent.

Kaplan and Zaojnik attribute the rise in the relative value of managerial ability to a variety of factors. Most interestingly, these include the need for public relations skills in dealing with external constituencies and increased media coverage.  Other factors include the need to be conversant with other disciplines -- economics, management science, accounting, finance. The authors argue that firm-specific skills are becoming less important because data are no longer "buried in the bowels of the organization," but are easily accessible by computers.

The authors conclude that the importance of general rather than firm-specific human capital means that

CEOs can capture the whole marginal product created by their transferable ability, but the lack of alternative use for their firm-specific skills means that they can only extract a fraction of the rents created by this part of their human capital. Therefore, a shift in the relative importance of general managerial ability will lead to higher wages even if overall managerial marginal productivity declines.

Nardelli illustrates this phenomenon in that he obviously has transferable technical skills, as discussed in my previous post. One might say that his Home Depot experience cast doubt on his ability to deal with external constituencies. But one might also say that that depends on how you want a CEO to deal with those constituencies.

Most importantly I love the irony here. Kaplan and Zaojnik are saying that part of what is driving executive pay up is the skill in dealing with Gretchen Morgenson and her ilk – the very people who are complaining about that pay.