Is CEO Pay Too High and Are Incentives Too Low? A Wealth-Based Contracting Framework

In the wake of the recent financial crisis, proposals have been put forward to resolve "problems" with executive pay and incentives. Although these proposals discuss ways firms or regulators might get executives to hold greater incentives, they fail to identify how one should determine whether an executive has enough (or too much) incentives. We lay out an economic framework for thinking about what level of performance-based incentives an executive should have. In doing so, we emphasize how performance-based incentives are linked to executive pay levels, as well as to the level of executives' wealth. We also make clear both the benefits and costs of performance-based incentives.