CEO bargaining power and compensation

Abstract Contracting theories predict that CEO power plays an essential role in the pay‐setting process. I provide causal empirical evidence of how changes in the bargaining power of CEOs affect the level of CEO compensation. Using the staggered rejections of previously adopted inevitable disclosure doctrine (IDD) by US state courts to capture an exogenous increase in CEOs’ bargaining power, I find that the IDD rejection results in higher levels of CEO compensation. The effect is strongest in firms whose CEO‐board dynamics is significantly influenced by the IDD—firms whose CEOs face greatest job mobility shock and firms that can effectively use the IDD decision as a bargaining tool against their CEOs. The economic magnitudes are substantial in those subsamples of firms, ranging from 22% to 54% increase in compensation levels.