CEO Compensation Packages Research Articles

Complexity of CEO compensation packages

This paper examines complexity in CEO compensation contracts. We develop a measure of compensation complexity and provide empirical evidence that complexity has increased substantially over time. We document that complexity results not only from factors reflecting efficient contracting, but also from external pressures from compensation consultants, institutional investors, proxy advisors, and attempts to benchmark to peers, with these external factors having greater impact in more recent years. Examining consequences of contract complexity, we find an association with lower future firm performance that is related to the influence of external factors on compensation design. We further find this relation is partially mitigated when a contract's performance metrics are more highly correlated, consistent with information processing costs hampering decision-making. Collectively, these findings confirm concerns raised by investors and the media regarding compensation complexity and can inform boards in their design of CEO pay packages.

Shareholder activism in listed family firms: Exploring the effectiveness of say‐on‐pay on CEO compensation

AbstractThe widespread critical evidence surrounding executive compensation of listed corporations has boosted shareholder activism in recent decades. The say‐on‐pay (SOP) mechanism—a vote in which shareholders express their (dis)agreement with executive pay designs—is one of the corporate governance mechanisms that has led to this activism among listed firms. Merging agency and socioemotional wealth (SEW) arguments, this paper analyzes how effective SOP voting results are among listed family firms in terms of CEO compensation efficiency and equity. Using a sample of UK listed firms from 2011 to 2018, our results show that SOP effectiveness is positively influenced by family ownership and is strongly moderated by family involvement in management and in governance as well as by family generation. Our findings stress the strong family effect and the ethical perceptions of family shareholders on SOP voting, showing how family participation in the firm encourages fairer and more aligned CEO compensation packages. SOP institutional and practical implications oriented to preserve shareholder value and family wealth are finally outlined.

Western cultural influence on corporate innovation: Evidence from Chinese listed companies

This study presents robust findings that Western cultural influence, as measured by Starbucks stores, significantly improves corporate innovation outcomes at nearby Chinese listed firms. These outcomes are generated by risk-taking in research and development investment, more aggressive CEO compensation packages, and tougher intellectual property protection. Our results show greater significance in areas where local cultural influence is less, industries are highly competitive, and non-state-owned enterprises are less prevalent. We generate insights into the cumulative and the incremental impact of Western cultural influence on firm innovation using yearly data on the number of Starbucks stores and new store openings within a given area.

Complexity of CEO Compensation Packages

Complexity of CEO Compensation Packages

The social-psychological perspective on executive compensation: evidence from a two-tier board system

This paper investigates whether and how social-psychological mechanisms, namely reciprocity, demographic similarity, and similar experiences, affect CEO compensation packages with respect to the levels of total, fixed, and short- and mid-term compensation and the variable proportion of the compensation package. We use evidence from Germany as it is considered a prototype of a two-tier board system. Given the primary roles of both the CEO and the chair of the supervisory board, we especially highlight social-psychological mechanisms in the process leading to the final compensation package. Using a hand-collected sample of non-financial constituents of the German HDAX, we find that reciprocity can lead to a compensation package that is more favorable for the CEO. Results on similarity are ambivalent such that the effects of similarity on CEO compensation—both positive and negative—may depend on the dimension of similarity. Finally, the chair’s CEO experience, both inside and outside the focal company, also plays an essential role in shaping CEO compensation. More specifically, CEO experience in general is associated with more favorable compensation. However, having a chair that has been CEO at the focal company correlates with less favorable compensation packages except for when the CEO has also been recruited internally.

The impact of corporate governance on the relationship between earnings management and CEO compensation

PurposeThe study examines whether corporate governance moderates the relationship between CEO compensation and earnings management.Design/methodology/approachThe study uses 1,800 firm-year observations from 2005 to 2010 and employ multiple regression analyses and other sensitivity tests.FindingsThe study finds a positive relationship between CEO compensation and earnings management. The study’s results also suggest that CEO bonus compensation increases in relation to earnings management and therefore the study infers that managers may become involved in earnings management to increase their compensation. However, the study finds that the relationship is moderated by a strong corporate governance system which reduces the impact of earnings management on CEO compensation.Research limitations/implicationsThe study is conducted in a specific context, and therefore it may be subject to a set of limitations. The study emphasises exclusively on whether executives manage earnings to increase their compensation. The study does not consider the issue of several other and potentially contradictory motivations here.Practical implicationsThe study’s findings highlight potential implications and offer useful propositions for stakeholders, particularly accounting and corporate governance regulators, to consider. The findings offer a basis for the accounting professions to further discuss and improve accounting standards to provide adequate regulations and monitoring to decrease managerial opportunistic behaviours in earnings manipulations. The findings also emphasise the need for appropriately designed CEO compensation packages in such a manner that improves the manager–shareholder alignment and reduces the information asymmetry problem. The results signify that corporate governance plays a vital role in mitigating the relationship between CEO compensation and earnings management.Originality/valueThis study adds to the existing literature by documenting empirical support on the link between earnings management and CEO compensation against a backdrop of high demand for strong corporate governance practices.

The effects of global financial crisis on the relationship between CEO compensation and earnings management

PurposeThis paper aims to examine the effects of global financial crisis (GFC) on chief executive officers’ (CEO) compensation and earnings management relationship. Specifically, the authors examine whether the recent financial crisis had moderated the relationship between CEO bonus and discretionary accruals.Design/methodology/approachThe authors use panel data for 1,800 firm-year observations (over a period of six years from 2005 to 2010) and use univariate and multivariate tests to test their hypothesis. The authors divide the period into pre-crisis, during-crisis and post-crisis periods to examine how the different financial crisis periods affect the relationship between CEO compensation and earnings management. Various alternative tests including endogeneity test suggest that the results are robust.FindingsThe authors’ multivariate results indicate that the relationship between CEO’ compensation and earnings management changes because of the GFC.Practical implicationsThe findings, therefore, justify more monitoring and scrutiny to limit the existence of opportunistic managerial behaviour and for the appropriate designing of CEO compensation packages during abnormal economic circumstances.Originality/valueSo far as the authors’ knowledge goes, this is the first study which examines the relationship between CEO compensation and earnings management during GFC.

The Social-Psychological Perspective on Executive Compensation: Evidence From a Two-Tier Board System

This paper investigates whether and how three social-psychological factors − reciprocity, similarity and role experience − affect CEO compensation packages with respect to the levels of total and fixed compensation and the variable proportion of the compensation package. We use evidence from Germany as it is considered a prototype of a two-tier board system. Given the primary roles of the CEO and the chairman of the supervisory board, we especially highlight social-psychological aspects of the above-mentioned relationship and emphasize the mechanisms in the process leading to the final compensation package. Using a hand-collected dataset we find that reciprocity in particular can lead to a compensation package that is more favorable for the CEO. Results on similarity are ambivalent to the extent that similarity is not a universal construct. It is rather that the effects of similarity on CEO compensation − both positive and negative − depend on the dimension of similarity. Finally, the chairman’s role experience also plays an important role in shaping CEO compensation. More specifically, role experience leads to increased variable compensation. Hence, it is worth noting that higher compensation does not seem to be granted unconditionally, although this could be concluded from theory and prior literature. When higher levels of compensation are paid, the increase often stems from an increase in the proportion of variable compensation.

Does CEO inside debt promote corporate innovation?

Given the nature of innovation, optimal incentive schemes to motivate innovation should exhibit substantial tolerance for failure in the short-term and reward for success in the long-term. Inside debt such as pension and deferred compensation is a long-term commitment contract and largely independent of CEOs’ short-term performance, making them more willing to engage in long-term innovation activities. This study examines the role of inside debt in a CEO's compensation package and shows that inside debt is positively associated with innovation. However, I also find that a high balance of inside debt compared to equity incentives, such as stock and stock option holdings adversely affects the CEO's incentives to innovate, implying important cross-sectional differences in a firm's optimal inside debt policies for innovation. The results are consistent after controlling for firm and manager fixed effects and reverse causality problems.

CEO compensation, portfolio holdings and strategic investments

PurposeThe purpose of this paper is to examine the relationship of CEO compensation plans and the risk of managerial equity portfolios with the extent of strategic investments in advertising, capital expenditures and research and development (R&D). The elements of compensation are salary, bonuses, options and restricted stock grants. The authors proxy the design of CEO equity portfolios by the price performance sensitivity of the holdings and the portfolio deltas.Design/methodology/approachThe authors use the components of executive compensation and portfolio risk as the dependent variables, regressing these against measures for the level of strategic investment. The authors test for non-linear relationships between the components of CEO compensation and strategic investments. The sample is a broad cross-section from 1992 to 2016.FindingsThe authors find strong support for non-linear relationships of capital expenditures and R&D with CEO bonuses, option grants and restricted stock grants. There are very complex relationships between the components of executive compensation and R&D expenditures, but little evidence of a relationship with advertising expenditures. The authors also find strong complex relationships in the design of CEO equity portfolios with advertising and R&D.Originality/valueLittle earlier research has considered advertising, capital expenditures and R&D in a unified framework. Also, testing for non-linear associations provides much greater insight into the relationship between the components of executive compensation and strategic investment. The findings represent a valuable incremental contribution to the executive compensation literature. The results also have normative policy implications for compensation committees’ design of optimal annual CEO compensation packages to incentivize or discourage particular strategic investment behavior.

CEO compensation and government ownership

AbstractResearch Question/IssueDespite the benefits of privatization (i.e., divestiture of government‐owned enterprises), governments still own substantial stakes in economically important firms. Given public concern about excessive compensation and frequent government responses, this paper compares the level and structure of CEO compensation in privatized firms, including those still partially owned by governments, to firms never owned by the government.Research Findings/InsightsUsing a multinational sample of firms, we find that privatized firms have lower total CEO compensation than private firms never owned by governments. CEO equity‐linked wealth in privatized firms is less sensitive to stock performance, and equity compensation is negatively related to government ownership stakes. Privatized companies engage in less risk‐taking than nonprivatized companies, suggesting that government risk aversion could explain differences in CEO compensation.Theoretical/Academic ImplicationsThis study finds that the role government ownership plays in the level and structure of executive compensation is broadly consistent with pay regulations governments periodically impose. It provides empirical support for the argument that government owners are risk‐averse and associated with lower equity‐linked executive pay, which discourages CEO risk‐taking.Practitioner/Policy ImplicationsThis study encourages corporate boards to consider the degree of government involvement in their firms when setting CEO compensation packages and policies. Government concerns about excessive compensation may require boards to find other ways to incentivize CEOs, particularly given the weaker governance linked to state‐influenced firms. Additionally, governments should analyze their influences on CEO compensation, and how these can affect performance, when considering their ownership stakes in public companies.

How the Design of CEO Equity-Based Compensation can Lead to Lower Audit Fees: Evidence from Australia

This paper investigates how the features of CEO equity-based compensation are associated with the agency costs of monitoring (measured by external audit fees) in an Australia setting. We find that audit fees significantly increase when firms award large equity grants to CEOs, which is consistent with the notion that auditors perceive higher risk associated with large equity incentives. However, by empirically testing auditors’ responses to the adoption of performance-vesting provisions, we document evidence that it is the use of accounting-based hurdles that potentially encourages unethical reporting issues. We report that audit fees are negatively associated with the use of market-based hurdles, while accounting-based hurdles lead to significantly higher audit fees but combination hurdles lower audit fees. To reduce the possible undesirable properties of accounting-based hurdles, firms adopt longer vesting periods to provide more balanced future-oriented incentives. Practical implications include the remuneration committee being aware of the hidden costs of poorly designed CEO compensation packages and avoiding undesirable ethical implications, particularly, where the CEO has significant power over the corporation.

CEO Compensation in the U.S.: Are CEOs Underpaid or Overpaid ?

This study investigates the adequacy of CEO compensation from the perspective of using accounting measures to assess the performance of CEOs. The main objective of this research is to determine to what extent compensation packages received by American CEOs represent an underpayment of CEOs based on the performance of their firms when firm performance is defined in terms of accounting measures. CEO compensation data are obtained from Compustat, 10K SEC filings, and Forbes listing of CEO data. The analysis covers a two-phased time period i.e., before and after the financial crisis in the USA. CEO compensation data are analyzed for the years 2004, 2005, 2006, and 2007 (pre-financial crisis) and for years 2009 to 2013 (post financial crisis). Multiple regression models consisting of six accounting performance measures are used to perform the analysis to determine the extent of CEO underpayment or overpayment. Having examined 1151 CEO compensation packages to determine if CEO underpayment exist in light of what is an overwhelming literature supporting CEO overpayment, the results show that 67.33% of the CEOs were in fact underpaid based on their firms performance, and only 32.67% (376 CEOs) were overpaid based on firm performance.

CEO risk preferences and hedging decisions: A multiyear analysis

Theory and previous empirical studies suggest that CEO risk preferences affect hedging. We challenge this idea in a 5-year time series setting by using inside debt (i.e., CEO pension and deferred compensation) and the CEO Vega and CEO Delta, as proxies of CEO risk preferences, and document that neither risk-averse (i.e., debt like compensation) nor risk-seeking (i.e., convex compensation) inducing CEO compensation packages influence corporate hedging. Moreover, we find CEOs who have more previous work experience and high job tenure to be positively related to hedging.

Creditor Influence and CEO Compensation: Evidence from Debt Covenant Violations

ABSTRACT Debt covenant violation alters firm dynamics, providing creditors with the right to demand repayment, and via that right, influence firm actions. We provide evidence consistent with creditors employing that channel to influence CEO compensation. Using regression discontinuity analysis, we show that in the year after a covenant violation, after controlling for other factors, CEO compensation is 8.5 percent lower and the CEO's compensation package contains fewer risk-taking incentives, as the vega associated with newly granted options is 26 percent lower. These changes are more pronounced when the creditor has greater influence, such as when the borrower and creditor have a prior lending relationship, the creditor is a highly reputable bank, or when the borrower is financially weaker. We also find that CEOs' risk-taking incentives decrease with the number of debt covenants; in particular, the number of performance debt covenants being breached. JEL Classifications: G21; G34.

Corporate social responsibility and CEO compensation structure

We examine how firms' corporate social responsibility (CSR) performance affects CEO compensation structure. Traditional agency theory suggests that CEOs engage in CSR for their own interests at the expense of shareholders. A competing argument is that CEOs consider firms' social performance as a business strategy to increase firm value and align their interests with those of shareholders. Our results support the latter prediction. We find that a firm's social performance is negatively associated with the proportion of cash-based compensation, while it is positively associated with the proportion of equity-based compensation. These results are robust to the degree of corporate governance, and they are more pronounced for firms with high levels of inside director ownership and long director tenure. Overall, our findings highlight the positive impact of CSR performance on CEO compensation packages, implying that CEOs' fiduciary behavior of engaging in CSR leads to mitigating agency problems and maximizing firm value.

Learning about the Details in CEO Compensation

I document the richness of CEO compensation packages and show that boards learn about the desirability of the many complex package features through observing how these features are associated with firm performance. I first capture the detailed features of plan-based awards for CEOs of the largest U.S. public firms in a vector with more than 1,300 elements. I then demonstrate the complexity of boards' decisions on adding and dropping the detailed features. I hypothesize that boards learn about the efficacy of complex features by observing their correlation with performance—both at their own firms and at other firms. To test these hypotheses, I measure the similarity between any two compensation packages using a metric that assigns a shorter distance to more similar packages. My results support my learning hypotheses: firms that perform well in the current year award similar packages to their CEOs in the following year, whereas firms that perform poorly significantly change their packages in the following year; moreover, firms adjust their own CEO compensation packages to be more similar to that of well-performing firms, and less similar to that of poorly performing firms. These results hold after controlling for the effects from compensation peer firms, compensation-consultant sharing firms, board interlocking firms, and product market peers. I further show that a focal firm experiences better performance when its CEO compensation package becomes more similar to those used by its well-performing compensation benchmark firms. This paper demonstrates the importance of capturing the multi-dimensional details of CEO plan-based awards and studying changes in compensation packages in a holistic manner.

Impact of executive compensation on the execution of IT-based environmental strategies under competition

Drawing on agency theory and the contingent natural resource-based theory, this study employs firm-level archival and survey data of US manufacturing firms to examine the impact of CEO compensation forms on the execution of IT-based environmental strategies and the moderating influence of competitive intensity on this impact. The findings reveal that CEO fixed pay and bonus negatively affect the execution of the two types of IT-based environmental strategies, green IT strategies and IT-enabled green strategies, whereas CEO stock option positively influences such execution. The moderation analysis further highlights that while competitive intensity reinforces the positive impact of CEO stock option on both strategies, it weakens the negative impact of CEO fixed pay and bonus only on IT-enabled green strategies. The findings suggest that a highly competitive operating setting represents an ideal setting for using stock option to motivate CEOs to execute these two strategies. At the minimum, this setting helps mitigate the deterrent effect of fixed pay and bonus on CEOs’ execution of IT-enabled green strategies. The findings also suggest that firms should align their CEO compensation package with the characteristics of high uncertainty and long payback periods of IT-based environmental strategic endeavors and the competitive conditions they face.

The Cult of the CEO: The Above Averagee Effect

Many CEOs earn more in one workday than the average worker makes in an entire year. The question is whether these extremely high CEO compensation packages undervalue the contributions that other employees make to the success of the company. What will the effect of excessive CEO pay have on employee morale? It also raises the question why companies with high CEO: worker pay ratios often have lower shareholder returns than companies with lower ratios. This article explores the reasons why such pay discrepancies continue to exist. The pros and cons of these excessive compensation packages are discussed, including the “above average” effect — and how this “above average” effect can have such a dramatic, inflationary impact on compensation packages. As self-policing by the CEO community seems unlikely, a number of countervailing measures are suggested that could keep the compensation game within reasonable boundaries.

The Role of the State as Controlling Shareholder in the Telecoms: Incentive Versus Entrenchment Theory

In this study we investigate the role played by the state as controlling shareholder in setting CEO incentives. Analyzing listed telecommunication companies from 13 European countries during 1999-2013, we measure the difference between the state and a private dominant shareholder in setting CEO compensation packages. We find that state control curbs the level of CEO compensation and this effect weakens as the state's ownership stake increases. When we focus on CEO incentive compensation, we report that CEO pay for performance sensitivity is higher for state controlled firms than for private firms. However, as the state's ownership stake increases, differences in sensitivity tend to disappear, but the effect of governance variables commonly used to proxy entrenchment becomes statistically significant.