Abstract
Since the pass of Sarbanes-Oxley Act (SOX) in 2002 and the subsequential changes in NYSE/NASDAQ, publicly traded firms in the United States have adopted the policies that increase board independence. Eventually, one phenomenon emerges when such governance practices go to an extreme—a CEO becomes the lone inside director on board. Furthermore, in the circumstance that the CEO also serves as board chair, the CEO becomes the “one-line liaison” between the board and the firm, possessing substantial power due to increase information asymmetry. While extant studies have shown that CEO power is among the critical determinants of CEO pay, little is known regarding how this corporate governance practice (CEO serving as both board chair and lone inside director) has an impact on top executive compensation design. This study is an effort to explore such impacts by developing competing theoretical arguments based on tournament theory and agency theory. The analysis of 2,093 observations of S&P 500 firms between 2006 and 2013 reports interesting findings. We find that, when a CEO serves as both board chair and lone inside director and becomes the “one-line liaison” between the board and the firm, the CEO receives much higher pay than their non-CEO TMT peers and such CEO-TMT pay gap is detrimental to firm performance. Our findings suggest that it is important to take a more nuanced approach when we examine the relationship between CEO pay gap and firm performance by considering the significant contingent effect of CEO power.
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