Recent economic literature has given a great deal of attention to the behavior of the firm under a regulatory constraint. Such efforts include theoretical extensions of the classic article by Averich and Johnson (1962) by Kennedy (1977), as well as empirical tests of the overcapitalization hypothesis by Leland (1974), Smithson (1978) and Spann (1974). In addition, there have been notable attempts to provide a general theory of regulation by Stigler (1971) and Peltzman (1976). Against this background, surprisingly little attention has been paid to the effect of regulation on the compensation of chief executive officers. The effect of regulation on executive rewards strikes at the heart of why regulated firms appear to behave differently than their less regulated counterparts. The only explicit attempts to relate executive compensation to the presence of regulation appear to be the work of Smyth, Boyes and Peseau (1975) and Ciscel (1977). The apparent oversight of this issue is perhaps best explained by the persistence of the controversy over the nature of the objective function of corporate decision makers introduced as the maximization' hypothesis by Baumol (1967). For the last two decades, the debate over whether corporate decision makers maximize sales or maximize profits has been couched in either-or terms. Proponents of each side of the debate, like Smyth, Boyes and Peseau (1975) and Ciscel (1974) on the managerialist side, and Lewellen and Huntsman (1970) and Masson (1971) on the neoclassical side, have produced evidence for their respective positions. Ciscel and Carroll ( 1980) provide an econometric resolution of the conflict, pointing out the compatibility of the data with both hypotheses, given a proper specification of the compensation-performance equations. Consideration of the impact of regulation on executive rewards has significance for understanding the different rewards in the regulated sectors and it illuminates the implicit incentives for executive behavior in regulated and unregulated firms. Maximum profits or optimal sales can never be directly observed. All that can be measured is whether or not the pattern of executive compensation is consistent with such maximization objectives. This aspect of economic analysis is particularly important when gauging the effect of regulation on executive pay. The impact of the absence of regulation on compensation can be contrasted to two alternatives: regulation establishes maximum prices as is the case in utilities, while regulation prescribed minimum prices as was the case in the transportation sector (see Jordan, 1972). Executive compensation reflects not only incentive changes brought about by the existence of regulation, but also the form regulation takes.

FOR over three decades, debate has raged over the economic assumption that the large corporation, through the decisions of its managers, attempts to maximize its profits. Empirical analysis of the behavior of the corporation has led to conflicting claims. The inquiry into the determinants of executive compensation has been no exception. Statistical investigation of executive compensation has been dominated by a search for one decisive explanation. Is the size, measured by either sales or assets, or profitability, measured by net corporate income or by the rate of return on assets, the key variable in establishing the level of the executive's reward? Proponents on both sides of this issue-the managerialists who support the corporate growth hypothesis and the neoclassical economists who favor the profit maximization assumption-seem to argue that the contest can be resolved by the presentation of unambiguous evidence that will award victory to one side and vanquish the other. This spirit of antagonism has distorted the essential element of the executive compensation question. The behavior of the corporation and the market forces that shape this behavior can be explained or illustrated only by the use of a series of intercorrelated variables. Not one of the available measures of corporate success, be it net income, sales or assets, is an exact measure of economic profits or firm size, nor is it independent of the other variables. This study focuses on the resolution of the serious econometric problems encountered in the process of estimating the determinants of executive compensation. Later we will show how the successful elimination of problems of simultaneous equations bias, multicollinearity and heteroscedasticity leads to the conclusion that the managerialist and neoclassical models of the firm are complementary, rather than substitute, explanations for the pattern of executive compensation.