Growth through Rigidity: An Explanation for the Rise in CEO Pay

We explore a rigidity-based explanation of the dramatic and off-trend growth in US executive compensation during the 1990s and early 2000s. We show that executive option and stock grants are rigid in the number of shares granted. In addition, salary and bonus exhibit downward nominal rigidity. Rigidity implies that the value of executive pay will grow with firm equity returns, which averaged 30% annually during the Tech Boom. Rigidity can also explain the increased dispersion in pay, the difference in growth rates between the US and other countries, and the increased correlation between pay and firm-specific equity returns. Regulatory changes requiring the disclosure of the value of option grants help explain the moderation in executive pay in the late 2000s. Finally, we find suggestive evidence that number-rigidity in executive pay is generated by money illusion and rule-of-thumb decision-making.