Do CEOs Set Their Own Pay? The Ones Without Principals Do

We empirically examine two competing views of CEO pay. In the contracting view, pay is used to solve an agency problem: the compensation committee optimally chooses pay contracts which give the CEO incentives to maximize shareholder wealth. In the skimming view, pay is the result of an agency problem: CEOs have managed to capture the pay process so that they set their own pay, constrained somewhat by the availability of cash or by a fear of drawing shareholders' attention. To distinguish these views, we rst examine how CEO pay responds to luck, observable shocks to performance beyond the CEO's control. Using several measures of luck, such as changes in oil price for the oil industry, we nd substantial pay for luck. Pay responds about as much to a \lucky" dollar as to a general dollar. Most importantly, we nd that better governed rms pay their CEOs less for luck. Our second test examines how much CEOs are charged for the options they are granted. Since options never appear on balance sheets, they might o er an appealing way to skim. Here again we nd a crucial role for governance: CEOs in better governed rms are charged more for the options they are given. These results suggest that both views of CEO pay matter. In poorly governed rms, the skimming view ts better (pay for luck and little charge for options) while in well governed rms, the contracting view ts better ( ltering out of luck and charging for options).