CHAPTER 17 • Markets with Asymmetric Information 647 Unfortunately, the means by which stockholders control managers’ behavior are limited and imperfect Corporate takeovers may be motivated by personal and economic power, for example, instead of economic efficiency The managerial labor market may also work imperfectly because top managers are frequently near retirement and have long-term contracts The problem of limited stockholder control shows up most dramatically in executive compensation, which has grown very rapidly over the past several decades In 2002, a Business Week survey of the 365 largest U.S companies showed that the average CEO earned $13.1 million in 2000, and executive pay has continued to increase at a double-digit rate Even more disturbing is the fact that for the 10 public companies led by the highest-paid CEOs, there was a negative correlation between CEO pay and company performance It is clear that shareholders have been unable to adequately control managers’ behavior What can be done to address this problem? In theory, the answer is simple: One must find mechanisms that more closely align the interests of managers and shareholders In practice, however, this is likely to prove difficult Among those suggestions put into effect recently by the Securities and Exchange Commission, which regulates public companies, are reforms that grant more authority to independent outside directors Other possible reforms would tie executive pay more closely to the long-term performance of the company EX AMPLE 17 CEO SALARIES Washington Mutual, an upstart savings and loan company, saw incredible growth throughout the 1990s and early 2000s A housing boom was in full swing, and the bank, led by CEO Kerry Killinger, was aggressive in pursuing new mortgages By 2007, however, Washington Mutual was in trouble As the housing market slumped and home values fell, it became clear that the bank had a dangerous number of sub-prime mortgages on its books By the fall of 2008, Washington Mutual’s assets had been seized by the FDIC and sold to competitor JP Morgan Chase at the fire sale price of $1.9 billion to avert what at the time would have been the largest bank failure in U.S history Less than three weeks before this sale, Washington Mutual’s board of directors fired Killinger Still, he received a severance package totaling over $15.3 million.10 Killinger’s successor, Alan Fishman, led the bank for just 17 days, but received $11.6 million in severance pay, in addition to a $7.5 million signing bonus.11 Washington Mutual’s shareholders were wiped out in the sale Killinger and Fishman were not the only bankers, or even the only CEOs, to receive large compensation packages, regardless of their performance and the health of the companies they led CEO compensation has increased sharply over the past few decades The average annual salary for production workers in the U.S went from $18,187 in 1990 to $32,093 in 2009 But in constant dollar terms, the 2009 average salary was only $19,552 (in 1990 dollars), which represents only a 7.5% increase At the same time, the average annual compensation for CEOs has grown from $2.9 million to $8.5 million, or about $5.2 million in 1990 dollars.12 In other words, while production workers have seen a 7.5% increase in their real wages over the past two decades, real CEO compensation has risen nearly 80% Why? Have top managers become more productive, or are CEOs simply becoming more effective at extracting economic rents from their companies? The answer lies in the principal–agent problem, which is at the heart of CEO salary determination 10 http://seattletimes.nwsource.com/html/businesstechnology/2011590001_wamuside13.html 11 http://www.nytimes.com/2008/09/26/business/26wamu.html 12 Source: Bureau of Labor Statistics, Institute for Policy Studies—United for a Fair Economy (2006) Average CEO pay peaked at $11 million in 2005, only to decrease during the 2007–2009 recession After 2009, it began to increase again