Signaling a successor? A theoretical and empirical analysis of the executive compensation‐chief executive officer succession relationship

Abstract

AbstractResearch SummaryExtant research rarely explores the relationship between executive compensation and chief executive officer (CEO) succession planning, despite practitioner claims that executive pay disparities indicate succession planning (in)effectiveness. Leveraging signaling theory, we use 830 succession events from 2010 to 2017 to show that pay disparity between the CEO and the highest paid non‐CEO executive is positively related to the likelihood of outside CEO succession. Thus, boards need to be aware of the implications of possible unintentional signals sent via executive compensation decisions. We do not find evidence of an interactive effect when compensation and CEO succession are co‐managed using linking pin directors—directors with compensation and CEO succession responsibilities—but supplemental analyses suggest a positive main effect of linking pin directors on the likelihood of inside CEO succession.Managerial SummaryPowerful watchdog agencies assert that high pay differences between a firm's CEO and its next highest paid executive (CEO–HPE pay disparity) indicate succession planning challenges. This assertion has profound implications for stakeholders, but evidence supporting it is unclear. Our study examines the relationship between CEO–HPE pay disparity and the board's choice of an outside CEO, an indicator of ineffective succession planning. We find evidence that higher pay disparity signals an increased likelihood of choosing an outside CEO successor. We also find that boards who co‐manage compensation and succession may be more likely to hire an inside CEO successor. Our findings suggest that boards need to understand how compensation decisions may be inadvertently signaling future CEO succession choices.