Discussion: “CEO Compensation in a Regulatory Environment: An Analysis of the Electric Utility Industry”

There is considerable evidence indicating that top management compensation is lower—both in terms of levels as well as the sensitivity to performance—in regulated firms, relative to unregulated firms. The question is why. There are two primary explanations. The investment opportunity set view (e.g., Smith and Watts [1992]) argues that the compensation in regulated firms is lower because it is commensurate with the talent and effort required to manage the limited investment opportunities faced by those firms. The political constraints view (e.g., Joskow et al. [1993]) argues that the scrutiny of regulators and consumers limits management compensation. Although the two views are not mutually exclusive, the point of departure is whether or not top management compensation would be lower in regulated firms, after controlling for differences in investment opportunity sets. The political constraints view predicts an affirmative answer, whereas the answer should be no under the first view.