Abstract
The disclosure of compensation peer groups is argued to provide shareholders with valuable information that can be used to scrutinize CEO compensation. However, research suggests that there are substantial incentives for executives and directors to bias the compensation peer group such that the CEO can extract additional rent. Analyses of eleven years of comprehensive data on compensation peer groups demonstrate that the average firm uses an upwardly biased peer group. The size of the bias is positively associated with poor firm performance and with the amount of structural ambiguity regarding the peer group that best matches the focal firm. Both of these relationships imply that firms select peer groups strategically in order to justify higher pay for the CEO. More importantly, upward bias in compensation peer groups is highly predictive of an increase in CEO compensation suggesting that there is a strong incentive for CEOs to introduce upward bias into the peer group. Finally, while average peer group bias has gone down in recent years, the predictive effect of bias on pay has gone up. These findings call into question the practical impact of recent efforts to introduce greater transparency into the process for determining executive compensation.
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