The Effect of Market Competition on CEO Compensation

This paper examines the effect of market competition induced by trade liberalisation on CEO compensation. Since economic theory cannot yet provide an explanation for the high level of CEO pay and until now very little empirical research on this topic has been undertaken, this investigation is of high value to shed light on the relation in question. The study uses a new concept to measure competition intensity by distinguishing between competition in goods markets and competition in factor markets. Hence, the amount of imports serves as a proxy for goods market competition, whereas the amount of exports is used as an indicator for competition intensity in factor markets. Additionally, a general equilibrium model is used to theoretically explain the relation between trade liberalisation, competition and management compensation. While the empirical analysis does not find clear evidence to support the a priori hypothesis that CEO compensation increases with the amount of exports and decreases with the amount of imports, the analysis reveals two key insights: (1) competition in goods and factor markets seems to effect CEO compensation in opposite directions, and (2) this result is reversed when bonus payments are observed, suggesting that more flexible elements of compensation react differently to competition intensity compared to more rigid forms of compensation.