Abstract
This paper investigates the role external advice plays in the board’s determination of CEO compensation. Specifically, I examine whether the Pay-Performance Sensitivity and the Relative Performance Evaluation component of a CEO’s contract increase with the degree of compensation consultant independence. I use a unique sample of Canadian firms which allows me to directly measure the impact of non-compensation related consulting fees on compensation advice. For identification, I exploit a 'quasi-natural experiment' provided by the creation of an independent consultant as a spin-off from an affiliated consultant. Switching to an independent consultant is associated with relative increases of 22% in Pay-Performance Sensitivity and 28% in Relative Performance Evaluation of CEO contracts. Despite the benefits of independent advice, independent consultants may not be hired due to higher fees, the influence of powerful CEOs, or because boards already possess adequate expertise.
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