Determinants of Executive Compensation: The Neoclassical Model Versus Concept Formation

Abstract

Neoclassical economic theory describes employee compensation as being equal to the worker's marginal revenue product. Other explanations of the wage formation process exist. For example, concept formation may enable employees to manipulate organizations and thereby receive higher compensation without changing their physical productivity. This study tests the two wage models on a 1983 data set of the 100 highest paid American chief executive officers. During 1983, the data appears to support the neoclassical economic model; while, the psychological model is not fully rejected. By contrast in an earlier study, for 1981, the psychological model took precedence over the economic model. The study fully reconciles the contrasting findings by introducing `stickiness in wages' to explain why concept formation impacts executive wages during stagnant economic periods, and why productivity assumes a greater role in setting executive compensation levels during robust economic periods.