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Abstract The real wage of the average worker in the United States has fallen 13 percent in the last 20 years, while the average chief executive officer (CEO) has received a pay raise of over 300 percent (Crystal, 1991). This glaring contrast has sparked an explosion in academic research on executive compensation. The argument that Crystal (1991) proposed, ¡°just about all of the rational factors you can think of, taken together, don¡¯t play a big role in determining executive pay¡±, is dominant in this medium. Despite this fact, research on executive paychecks has continued to grow as the literature is truly interdisciplinary across the fields of economics, finance and accounting, industrial relations, organizational behavior and strategy (Murphy 1999). Labour economists have drawn upon many conclusions on executive remuneration from a large theoretical and empirical interdisciplinary literature. They argued that executive remuneration offers opportunities to analyze many concepts of the economics of managerial labor market. Hence, in this essay I am going to explore these opportunities by looking at the functioning market in the captioned perspective. The managerial labor market, which contains a range of firms that are with managerial jog openings and a range of potential managers who have different human capital characteristics, has two sides. On the one hand, the demand side, which is made up of employees who produce goods and services, and employers who purchase executive effort, concerns paid managerial labor as a function of the latter¡¯s pay and productivity. On the other hand, the supply side composes executives who are assumed to switch firms according to the characteristics of the firm and the salary. By understanding the two sides and the disciplining effect of the managerial labor markets, firms can identify the market forces that determine the optimal executive remuneration contracts so as to maximize firm value (Fama 1980, Fama & Jensen 1983). The use of such knowledge align with the understanding of managerial behavior with owners¡¯ interests can help firms to choose corporate policies that best signal their own value to the labor market such as CEO remuneration. Since one of the most important objectives of firms is to maximize their value, executives are disciplined into undertaking strategies preferred by the stockholders that maximize the firm¡¯s stock price (Fama 1980). Hence, suggesting the major functioning of managerial labor market are to determine the rational level and structure of remuneration package and to reflect the managerial labor market¡¯s control of executives¡¯ behavior to maximize firm value. Despite the fact that executive remuneration schemes across firms and industries are substantially heterogeneous and complex, it can boiled down to four basic elements: a base salary, bonus, stock options and long term incentive plans. I will examine these in turns. First, base salary for executives is a key component of the pay package. It represents the ¡° fixed component¡± in executive contracts. Second, bonus is paid annually based on accounting profit, budget, prior-year performance or incentive zone. Third, stock options are agreements that the executive may purchase from the firm at any time within a stated period or a given number of shares of its stock at a price specified on the date of granting (Easton & Rosen 1983). This, with regards to political, economic, mechanical and behavioral factors, has made it the most pronounced method in executive remuneration in the last two decade (Murphy 1999).
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