Managerial discretion and managerial compensation

This paper examines two hypotheses regarding the determinants of managerial compensation. The one views managers as being hired by the owners of the firm to provide managerial services, and sees their compensation as a purely functional return for services rendered. It uses a simple model of bureaucracy to explain managerial compensation. The second model assumes that managers set their own salaries. It uses estimates of returns on investment to measure the degree to which managers have and exercise discretion in their investment policies. This measure of discretion is also found to explain why some managers receive higher salaries than are predicted by the bureaucracy model.