March 28, 2007 -- Why has CEO pay increased so much—some 600 percent—since 1980? Were corporate directors who consistently received stock options at the most favorable prices just lucky—or is there more to the story? Can corporate governance reforms be correlated to increases in firms’ market values?
These were just some of the questions addressed by participants in the Conference on Law and Finance, held March 23-24, 2007, and co-sponsored by the John M. Olin Program in Law and Economics and the McIntire School of Commerce. Conference participants included luminaries in both law and finance, including Pete Kyle of the University of Maryland’s Smith School of Business; Jeffrey Gordon of Columbia Law School; and Augustin Landier of NYU’s Stern School of Business.
“We were thrilled to have been able to assemble such an absolutely world-class roster of participants,” said conference organizer and McIntire Finance Professor David C. Smith. Smith said that working toward an integrated understanding of law and finance is crucial, pointing out that recent advances in economic theory, as well as a growing body of empirical evidence, have highlighted the strong connections between the two subjects.
“Today’s financial economists rely heavily on the characteristics of legal institutions and contracts to explain the behavior of corporations and markets, while today’s scholars in law often draw on financial theories and data to critically examine the organization and structure of law,” Smith said. “We wanted to facilitate a real-time dialogue between the leading scholars in both fields, with the object of pushing both fields forward and advancing the understanding of the two fields as they relate to one another.”
The conference was structured such that the presentation of a scholar in one field would be answered by the commentary of a scholar from the other, followed by questions from the audience.
Stern’s Landier, for instance, spoke on his much-publicized research (co-authored with Xavier Gabaix of Princeton, MIT, and the National Bureau of Economic Research) into why American CEOs’ pay has increased so dramatically over the past 23 years. Landier said his research showed that the increase in CEO pay correlated almost exactly with an increase in corporations’ market capitalization (i.e., the number of shares outstanding x current share price). That is, CEO pay may have increased six-fold since 1980, but so has the market value of American companies. Moreover, Landier said, “very small differences in CEO talent justify very large pay differences, because those differences are magnified throughout the whole company and may ultimately translate into millions of dollars in market value.”
Landier’s presentation was followed by commentary by Reinier Kraakman of Harvard Law School, who raised such questions as why the length of CEOs’ tenure has plummeted over the same time period that pay has skyrocketed, and how quantifiable “talent” is. Audience participants then asked probing questions about the means by which market capitalization increased, theorizing that if CEOs were aware of the market cap-salary link, they would be very much incentivized to boost share prices. Others questioned the timeframe upon which Landier had chosen to base his argument, stating that U.S. stock markets boomed after World War II well into the 1960s, while CEO pay remained largely flat.
Said Smith, “Discussions of this sort raise important questions about the effects of financial trends throughout society and how law and regulation play a role in affecting these trends.”