Compensation Consultants Research Articles

CEO performance targets: The impact of Big 4 accounting firms versus other compensation consultants

Using a sample of ASX 500 firms over the 2005–2019 period, we document substantial variation in the use of performance targets within Chief Executive Officer (CEO) compensation contracts, contrasting firms advised by Big 4 accounting entities with other compensation consulting firms. Firms that engage a Big 4 accounting firm are more likely to implement explicit non-financial performance targets within the short-term incentive plan, effectively minimising opportunities for post hoc justification. They also favour the incorporation of relative performance targets that mitigate pay for luck in the long-term incentive plan. Firms that engage a Big 4 accounting firm demonstrate a similar pay-for-performance relation to firms that do not engage a compensation consultant, while firms engaging non-Big 4 consultants exhibit a lower pay-for-performance relation. Our findings suggest that Big 4 accounting firms provide compensation recommendations that encourage the alignment of interests between managers and shareholders. JEL Classification: J33, M12, M52, L25

Compensation peer effects of corporate social responsibility

This article examines the role of CEOs' personal incentives in steering their firms' CSR initiatives following their compensation peers, subsequently influencing their career trajectories within their current firms. Specifically, we find that firms exhibit better corporate social responsibility (CSR) performance if their compensation peer (CP) firms demonstrated superior CSR performance in the prior year (i.e., the CP effect). To mitigate the endogeneity concern, we conduct analyses based on the termination (initiation) of CPs' peer relation with the focal firm, a benchmark test, and an instrumental variable analysis. To establish the mechanisms of internal monetary rewards from their firms and enhanced external career tournaments in the labor market, we show the CP effect is stronger if the focal company CEOs have compensation contracts specifying CSR performance targets, face a larger compensation shortfall relative to their CP counterparts, operate in closer geographical proximity to those CP CEOs, or hire more compensation consultants. Furthermore, we find that the probability and quantity of CSR contracts received by focal firms' CEOs increase with CPs' lagged CSR. CEOs receive higher compensation than those in CP firms after they deliver better CSR performance than their CPs. Overall, our paper highlights the role of CEOs' personal incentives in steering their firms' CSR initiatives, subsequently influencing their career trajectories within their current organizations.

The impact of unions on compensation consultants and CEO pay

AbstractResearch on executive compensation finds unions to be associated with lower executive compensation, particularly incentive pay, while other work documents the role of compensation consultants in facilitating stronger CEO incentives and pay. We propose and test the implications of a simple theoretical framework that integrates these empirical findings. We find empirical support for our model's prediction that in environments less favorable to union organization (e.g., right‐to‐work states), firms with higher unionization rates strategically engage consultants to counter union influence, place greater value on their advice as gauged by consultant fees, and offer managers greater equity incentives opposed by unions. On the other hand, in strongly prolabor environments, unions are more successful at curtailing consultant use and have greater influence on the level of pay and incentives.

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.

Compensation Consultants, Limited Participation, and CEO Pay

Compensation Consultants, Limited Participation, and CEO Pay

Curse or Blessing? The Use of Subjective Performance Evaluation in the Digital Era

Subjective performance evaluation (SPE) in executive compensation raises concerns among investors due to a potential lack of pay-for-performance. However, while these concerns are reasonable, subjective performance evaluation can also supplement the incompleteness of objective performance measures and thereby improve incentive contracting. Based on this reasoning, we believe that SPE is essential for the progress of digital innovation where conventional performance measures typically fail to provide accurate information. Our results empirically verify that the adoption of SPE indeed encourages executives to engage in digital innovation. Moreover, we find that this positive association depends on CEOs' perception of director's ability and willingness to deviate from objective results when making subjective evaluations. Thus, our results are valuable for investors, firms, and compensation consultants thinking about SPE and struggling with digital innovation.

The choice of performance measures, target setting and vesting levels in UK firms' Chief Executive Officer equity‐based compensation

AbstractThis article analyses factors influencing the choice of performance measure in CEO equity‐based compensation, for a sample of 3,400 plans from 400 UK firms between 2007 and 2015. We examine the effect of the volatility of earnings per share (EPS) and of total shareholder returns (TSR) on the choice of performance measures, taking into account four categories of measure: EPS alone, TSR alone, EPS and TSR jointly, or neither EPS nor TSR. This allows us to utilize a comprehensive cross‐section of plans. The results are robust to controlling for plan types, the use of different compensation consultants, industry and time‐specific effects. We find that “EPS and TSR jointly” is the most common category of performance measure employed by firms. Our empirical results show that firms with higher EPS volatility and lower TSR volatility are more likely to choose TSR as a performance measure and that firms with higher EPS volatility are less likely to choose EPS alone; we argue that these results are consistent with optimal contracting theory. Second, we conduct a novel, detailed description of the performance measures, comparator groups, plan choices, threshold targets and vesting levels at minimum and maximum thresholds, used in CEO compensation contracts. We further argue that commonalities across firms in the elements of target‐setting are evidence of institutional isomorphism.

Compensation Consultant Considerations Related to Equity Incentive Compensation Programs

Compensation consultants often advise private companies to use equity incentives to attract and/or retain employees. This practice has become common during recent periods of labor shortages and low unemployment rates. This discussion summarizes what compensation consultants need to know about taxation and security valuation issues related to private company equity incentive compensation programs.

Pay for Outsiders: Incentive Compensation for Nonfamily Executives in Family Firms*

ABSTRACTWe use a hand‐collected sample of 1,628 S&P 1500 firms and more than 12,000 executives to examine how family firms compensate nonfamily executives. Family firms comprise a large percentage of firms around the world, and most of their executives are not members of the founding family. Moreover, the founding family's engagement in the firm alters agency conflicts, which in turn should influence the design of incentive compensation. However, there is no empirical evidence on whether and how the incentive compensation of nonfamily executives differs between family and nonfamily firms. Our study intends to fill this gap in the literature. Consistent with our predictions, nonfamily executives in family firms receive significantly less performance‐based pay and equity‐based pay. Family monitoring, risk aversion, and a reluctance to dilute family ownership all contribute to the pay differences. Although incentive pay and total pay are lower in family firms, nonfamily executives receive safer pay and enjoy greater job stability. An analysis of executives' moves across firms suggests that ownership structure, not executives' preferences, is more likely the driver of pay differences between family and nonfamily firms. Our findings suggest that researchers should consider founding family's engagement to avoid misleading inferences with regard to the determinants of incentive compensation, and our findings should help compensation consultants better understand and implement pay packages for family firms and nonfamily firms. The results also imply that uniform compensation regulations intended to improve the monitoring of executives in widely held firms may not be as effective in family firms.

How COVID-19 reshapes businesses and executive pay for sustainability

The purpose of this paper is to answer the research question of how to design a fair and resilient compensation scheme according to stakeholder theory and the sustainability concept. The first finding of this paper is the framework for the sustainable, fair, resilient, scientific, simple, and practical compensation schemes — pay for sustainability (P4S). P4S has been developed after reviewing the literature and obtaining insights from the compensation consultants in Switzerland. It is also a useful tool in COVID-19 and will be for future crises. As a second finding, this theory-adaptation-based conceptual and commentary paper criticizes the conventional executive compensation structure and introduces the business lessons learned from the COVID-19 crisis. As a contribution to both the literature and practice, this research advances the novel knowledge in the field by conceptualizing a reliable and scientific framework and explaining the advantages and disadvantages of the four methods of the P4S framework. During COVID-19, environmental, social, and governance (ESG) based performances and compensation schemes have gained more importance. Finally, these proposed methods contribute to the adaptation of ESG-based compensation schemes while considering the local and individual differences of organizations

Compensation consultants: Does reputation matter?

In this paper, we analyze the role of hiring a reputable compensation consultant for firms wanting to secure affirmative Say on Pay (SoP) votes. We provide evidence that reputation influences shareholders voting behavior positively when CEO pay is excessive and when peer CEOs are paid less. We employ two methods to account for endogeneity, instrumental variables as well as examining firms switching up to more reputable compensation consultants. Our results are robust with respect to CEO pay and complexity as well as fees and alternate measures of reputation. Firms concerned with the negative feedback associated with negative SoP votes should factor reputation in their decision to hire consultants, especially if trying to adopt compensation packages that may appear excessive.

Compensation Consultant Fees and CEO Pay

ABSTRACTWhile compensation consultants are known to play an important role in the design of executive compensation contracts, evidence on the effect of consultant incentives on CEO pay is mixed. Using compensation consultant observations with mandatory fee disclosures, which a prior study identifies as an optimal pay setter, we examine whether CEO pay is associated with consultants' incentives to retain clients, measured by fees for executive compensation services. In contrast to previous studies that find no support for repeat business incentives, we find evidence that CEO pay is higher when consultants receive abnormally high fees, demonstrating a strong incentive to retain the client, and that this positive association occurs only in weakly governed firms. This finding highlights the importance of consultant incentives and corporate governance in executive compensation settings.JEL Classifications: M12; G34; G38.Data Availability: Data used in this study are publicly available.

Early Retirement Windows

An early retirement window is an offer, by an employer, of a special incentive to retire at a particular time, beyond that provided by the firm's pension plan. While such windows have attracted increasing attention in the academic literature and the business press, most of our current knowledge about them is based case studies or compensation consultants' surveys of their clients. The Health and Retirement Study provides an opportunity to analyze the incidence and consequences of such offers among a representative sample of workers who are in the age range (51-61 in 1992) where such windows may be important. HRS data suggest that window offers increased in the early 1990s. At their peak in the mid-1990s, employers were making about 5 offers per 100 workers age 55-59. One third of the offers were accepted. The economic impact of window offers depends the extent to which those who accept such offers would have left the employer soon anyway, and those who are induced to leave one employer go to work elsewhere. But multiplying the frequency of such offers by the acceptance rate suggests a substantial potential impact the employment of workers in the HRS age range. Window offers are generally made to workers in career jobs. Such workers have above-average education, tenure with employer, and earnings. The attachment between the employer and such workers is often strengthened by defined-benefit pension plans, which discourage leaving before the early-retirement age of the pension plan but often also provide sharp incentives to leave on time. Workers who received window offers were closer to early retirement age (as defined by their pension plan), and were expecting to retire sooner than other workers. Thus, one might expect that those who receive window offers would have retired earlier than other workers, even without the special window incentive. On the other hand, those receiving window offers are better paid and in better health than the average worker, and these differences would encourage them to retire later. Workers who received window offers worked in jobs that had cognitive rather than physical demands, and there is some evidence that those most affected by technological change were more likely to receive an offer. Window offers with up front cash incentives offer, average, six to eight months pay; those featuring increased pension benefits are more generous. Accepted offers tended to be those with more generous cash incentives and were more likely to include increased pension benefits, increased service credit (which indirectly raises pension benefits), and health insurance. Those who received window offers are less likely to be working at subsequent waves of the HRS; this effect is larger at the interview following the window offer (where those receiving an offer are 15 percentage points less likely to be employed), but declines fairly rapidly thereafter. Controlling for a wide variety of variables that are related to receiving a window offer and to the probability of being employed does not change the short-run impact significantly, but increases the rate at which the impact declines in later waves.

Predicting CEO Compensation in Non-Controlled Public Corporations with the Canonical Regression Quantile Method

Empirical research on the relationship between CEO compensation and corporate performance has, as of yet, failed to yield meaningful results. Evidence instead points to the decoupling of CEO total compensation (salary, bonus, other payments, and stock options) from the corporate performance. Recent work by Barton et al (2017) suggested a predictive model where public corporations engaging in long-term operational and financial goals achieve superior performance and market results in the long-term. The suggested predictive power of this long-termism could provide a quantitative measure of future corporate performance that is tied to current CEO action. If true, this model can be used as a proxy to establish future CEO compensation. Corporate ownership structure can influence CEO compensation to reflect ownership powers rather than corporate performance. Therefore, we limited our research to non-controlled public corporations – those with a single class of shares and without blockholders. The analysis here uses Canonical Regression Quantiles to produce an Index based on past data in order to predict CEO compensation two years ahead (see Portnoy and Haimberg, 2020). The regressions on Index are significant, but not overwhelmingly so, but provide a useful tool to separate over-compensated from under-compensated CEOs, and are a method to determine current CEO compensation. Results: The use of the Canonical Regression Quantiles’ Index proved that non-controlled companies that invest in long-termism post superior future performance. The Index indicates that current CEO compensation influences future performance. The Index provides a method for determining CEO pay for the next 1-2 year and is a useful method to distinguish over/underpaid CEOs as an unbiased alternative to the peer groups comparison used by most compensation consultants. This determination is statistically weak, but future research using the Canonical Regression Quantiles with a larger data set may lead to increased sensitivity and a powerful unbiased method for replacing compensation consultants who are responsible for the decoupling of CEO compensation and corporate performance.

‘Grand challenge’ or ‘not an issue’? The discourses on income inequality of compensation managers and consultants

Within the broader debate on the increase of labor income inequality, social concerns have growingly focused on organizational practices. Among these, market-oriented compensation practices, with their extensive pay dispersion, are deemed crucial ‘inequality-generators’. Based on 49 interviews with Italian compensation managers and consultants, this article explores whether, in their talk, these actors align with (or detach from) inequality-increasing compensation practices, and which discourses they employ to justify their posture. By resorting to the discourses on meritocracy and market, the respondents fully supported dispersed market-based compensation structures, thus endorsing a motivation- (rather than legitimacy-) centered approach informed by a shareholder (rather than a stakeholder) perspective. In countering possible criticisms, they advanced two main discursive responses: ‘transparent communication’, i.e. communication intended to convince critics about the benefits of merit-based and market-based pay dispersion; and ‘populism’, i.e. a term used to discredit those critics that question any type of pay dispersion. Assuming a discursive approach, the paper adds an HRM perspective to the growing debate on the role of organizations in producing and re-producing income inequality, while critically showing that compensation managers and consultants fail as a resource for inequality reduction.

Litigation Risk and the Independent Director Labor Market

After decades of declining litigation risk, independent directors of public companies are viewed as effectively immune to personal litigation costs. However, the unexpected In re Investors Bancorp decision by the Delaware Supreme Court in 2017 lowered the liability threshold only for directors in derivative litigation over their own equity grants. Investors and firms both reacted to this rare increase in director-only litigation risk. First, Delaware firms experienced significant negative short-window returns, concentrated in firms where equity compensation is most important, consistent with investor concerns about attracting and/or retaining qualified directors. Second, Delaware firms added more qualified directors to the compensation committee. Third, Delaware firms with higher abnormal compensation decreased director compensation. Finally, Delaware firms decreased discussion of director pay in 8-K filings and their use of compensation consultants. Overall, results are consistent with firms acting to mitigate litigation concerns.

Compensation consultants’ reputation, non-compensation consulting services and CEO pay

ABSTRACTIn this study, we draw on the reputation and product quality literature to examine whether compensation consultants with higher reputation have incentives to provide higher-quality services in terms of CEO pay level and pay performance sensitivity (PPS). Using 1,827 US firm-year observations for 2009 and 2010, we find that consulting firms with a higher reputation, proxied by consultant size, are associated with lower compensation and higher PPS. We also find that the PPS for consultants that also provide non-compensation-related services (NCS) is significantly positive for consultants with a higher reputation, consistent with the reputation protection explanation, and significantly negative for the other consultants with a lower reputation consistent with the conflict of interest argument.

Evidence on compensation consultant fees and CEO pay

Regulators and previous research have expressed concern about the effect of compensation consultants on CEO pay. We use the Australian setting, where fees for both compensation and other consulting services supplied by compensation consultants are mandated disclosures for all firms, to provide evidence on the role of compensation consultants on CEO pay. We find that the use of compensation consultants or remuneration advisers, fees for compensation services and positive residual compensation service fees are associated with higher CEO pay. In contrast, both the provision and the proportion of fees from other services provided by compensation consultants are not. Furthermore, these positive associations are not observed when a Big 4 accounting firm is the compensation consultant. JEL Classification: G38, M12, M48, M52

Compensation Consultants and the Level, Composition, and Complexity of CEO Pay

ABSTRACT We provide fresh evidence regarding the relation between compensation consultants and CEO pay. First, firms that employ consultants have higher-paid CEOs—this result is robust to firm fixed effects and matching on economic and governance variables. Second, while this relation is partly due to consultant conflicts of interest, it is largely explained by the impact consultants have on the composition and complexity of CEO pay plans; notably, this impact fully mediates the consultant-CEO pay relation. Third, firms with higher-paid CEOs and more complex pay plans are more likely to hire a consultant. Last, Say-on-Pay voting patterns suggest shareholders view positively the advice consultants provide, but only when consultants provide no other services. We also find suggestive evidence of boards “layering” new equity incentive plans over existing ones, thereby increasing the impact of composition and complexity on CEO pay beyond the premium the CEO would demand for bearing additional compensation risk. JEL Classifications: J33; M12; M52; M48. Data Availability: Data are available from the public sources cited in the text.

RTSR: When Do Relative Performance Metrics Capture Relative Performance?

We examine the properties, determinants, and consequences of peer benchmarks chosen by firms to evaluate relative total shareholder returns (rTSR) in executive relative performance contracts. Among firms that explicitly use rTSR, 60% select specific peer firms while 40% select a stock index as benchmarks. Consistent with the intent to filter out the systematic component of TSR, firms' chosen benchmarks exhibit a return-regression slope coefficient of 1 and remove a significant amount of systematic noise in TSR. However, index-based benchmarks are considerably noisier compared to those based on specific peers. Inconsistent with standard contracting models, firms using index-based benchmarks do not exhibit relatively lower pay-to-performance sensitivities, nor do they face lower gains from filtering precision. Instead, index-benchmark use is associated with weaker corporate governance and compensation consultants' preferences, which are uncorrelated with observable firm attributes. The use of index-based benchmarks is also associated with lower ROA, even after controlling for benchmarks' noisiness and companies' governance attributes. Our analyses suggest the salience of peer comparisons as an important attribute of relative performance benchmarks.