Executive Compensation: A Calibration Approach

We use a version of the Grossman and Hart (1983) principal-agent model with 10 actions and 10 states to produce quantitative predictions for executive compensation. Performance incentives derived from the model are compared with the performance incentives of 350 firms from a survey by Michael Jensen and Kevin Murphy. The results suggest both that the model does a reasonable job of explaining the data and that actual incentives are close to the optimal incentives predicted by theory.