IZA World of Labor

Market competition and executive pay

Increased competition affects the pay incentives firms provide to their managers and may also affect overall pay structures

University of Minho, Portugal

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Elevator pitch

Deregulation and managerial compensation are two important topics on the political and academic agenda. The former has been a significant policy recommendation in light of the negative effects associated with overly restrictive regulation on markets and the economy. The latter relates to the sharp increase in top executives’ pay and the nature of the link between pay and performance. To the extent that product-market competition can affect the incentive schemes offered by firms to their executives, the analysis of the effects of competition on the structure of compensation may be informative for policy purposes.

Difference in log payment between CEOs and
                        other workers

Key findings

Pros

Regulatory changes aimed at easing the process of starting up a business are likely to foster output growth and employment at no additional expense to the public.

To motivate and elicit effort from their managers, firms are likely to design explicit or implicit employment contracts that relate their pay to performance.

Executives’ compensation schemes are related to the levels of product-market competition.

Cons

Barriers to firm entry have negative effects on the economy (e.g. on competition, innovation, employment, wages, etc.).

While in most studies increased competition leads to stronger incentives provided by firms to their managerial workers, this is not necessarily always the case.

As firms can substitute fixed for variable pay (and vice versa), the overall effect of changes in competition on the executives’ pay remains uncertain.

Author's main message

Empirical evidence suggests that executive pay is related to the level of product-market competition. However, while most shocks or policy reforms that foster competition tend to strengthen the link between competition and performance-related pay, it can also be the case that increasing competition reduces incentives. Also, as firms may change their pay structures, the effect of changes in competition to CEOs’ pay is uncertain. Policies aimed at reducing wage inequality or at affecting the provision of incentives should consider market idiosyncrasies as well as taking these different effects into account.

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