Level Of Executive Compensation Research Articles

Executive Superstars, Peer Groups and Over-Compensation – Cause, Effect and Solution

In setting the pay of their CEOs, boards invariably reference the pay of the executives at other enterprises in similar industries and of similar size and complexity. In what is described as “competitive benchmarking”, compensation levels are generally targeted to either the 50th, 75th, or 90th percentile. This process is alleged to provide an effective gauge of “market wages” which are necessary for executive retention. As we will describe, this conception of such a market was created purely by happenstance and based upon flawed assumptions, particularly the easy transferability of executive talent. Because of its uniform application across companies, the effects of structural flaws in its design significantly affect the level of executive compensation. It has been observed in both the academic and professional communities that the practice of targeting the pay of executives to median or higher levels of the competitive benchmark will naturally create an upward bias and movement in total compensation amounts. Whether this escalation has been dramatic or merely incremental, the compounded effect has been to create a significant disparity between the pay of CEOs and what is appropriate to the companies they run. This is not surprising. By basing pay on primarily external comparisons, a separate regime which was untethered from the actual wage structures of the rest of the organization was established. Over time, these disconnected systems were bound to diverge. The pay of a chief executive officer, however, has a profound effect on the incentive structure throughout the corporate hierarchy. Rising pay thus has costs far greater than the amount actually transferred to the CEOs themselves. To mitigate this, boards must set pay in a manner in which is more consistent with the internal corporate wage structures. An important step in that direction is to diminish the focus on external benchmarking. We argue that: (I) theories of optimal market-based contracting are misguided in that they are predicated upon the chimerical notion of vigorous and competitive markets for transferable executive talent; (II) that even boards comprised of only the most faithful fiduciaries of shareholder interests will fail to reach an agreeable resolution to the compensation conundrum because of the unfounded reliance on the structurally malignant and unnecessary process of peer benchmarking; and, (III) that the solution lies in avoiding the mechanistic and arbitrary application of peer group data in arriving at executive compensation levels. Instead, independent and shareholder-conscious compensation committees must develop internally created standards of pay based on the individual nature of the organization concerned, its particular competitive environment and its internal dynamics.

Management Insights

Management Insights

Re-Examining the Determinants of Executive Compensation in the Restaurant Industry: A Quantile Regression Approach

This study investigates the determinants of executive compensation in the restaurant industry with selected variables from both the pay-for-performance rule and the managerial power approach, using a quantile regression method. The quantile regression method also provides an empirical illustration that different levels of executive compensation are related differently to the pay-for-performance and managerial power variables. The results of the quantile regression analysis support the hypotheses that executive corporate governance influences executive compensation and that the restaurant industry partially follows the pay-for-performance rule to determine executive compensation.

Institutional Investor Preferences and Executive Compensation

In this paper, we investigate the attitudes of institutional investors, such as hedge funds, insurance companies, mutual funds and pension funds, towards a key corporate governance mechanism, namely executive compensation. We document the preferences they have about both the level and structure of executive compensation. Our analysis takes a comparative approach as we ask investors to reveal their preferences both for firms in the U.S. and in The Netherlands. Our analysis further sheds light on who should decide on executive pay, thereby contributing to the recent debate on shareholder involvement in executive pay. Finally, we examine their views on the most important and largest component of executive pay, executive stock options, and investigate what preferences they have when it comes to the design of such options.

Crowding Theory and Executive Compensation

Payment for performance is widely embraced as a key component of any well-designed executive compensation package. There is a price to be paid, however, for the heavy reliance on incentives as a way of controlling agent behavior. In particular, evidence exists demonstrating that incentives can crowd out an agent’s social preferences towards her principal. Social preferences are pro-social tendencies of people to do things for others for reasons such as fairness, reciprocity, altruism, and ethical or moral beliefs. The use of incentives in compensation can result in self-interested agents. When crowding out occurs, in order to elicit the desired level of performance, principals may need to increase the level of incentive employed. Crowding out therefore provides an additional account for rising levels of executive compensation. In addition, crowding theory can provide a helpful explanation for the tension around the U.S. government’s reaction to preexisting banker incentive contracts during the 2008 financial crisis.

Institutional ownership and executive compensation

Purpose – The purpose of this paper is to examine the association between institutional investor ownership and the compensation of executives at US banks during the financial crisis period.Design/methodology/approach – This paper uses a linear regression model to examine the association between institutional ownership and the level of executive compensation at US banks.Findings – Institutional investors influence executive compensation at banks with the impact being most pronounced for the CEO. Ownership by the top five investors is associated with greater total compensation. Active investors have the strongest impact on executive compensation as evidenced by a positive association between active ownership and both equity compensation and total compensation. As well, active ownership is negatively associated with bonus compensation. The paper also finds that passive and grey investors influence compensation but to a less significant extent than active investors.Research limitations/implications – The resu...

EXECUTIVE PAY DETERMINATION AND FIRM PERFORMANCE—EMPIRICAL EVIDENCE FROM A COMPRESSED WAGE ENVIRONMENT*

Using representative register and questionnaire data on Norwegian firms and workplaces we study the relationship between firm performance, CEO compensation schemes and the level of executive compensation. On average no relationship is found between executive performance pay and firm productivity. These relationships vary between industries, and CEO performance pay is strongly associated with high‐productivity manufacturing firms. On average CEOs receive higher earnings under performance pay than under fixed pay, even controlled for productivity and industry differences. Thus the earnings of executives appear more strongly related to the choice of executive remuneration scheme than that of the performance of firms.

Board Reputation, CEO Pay, and Camouflaged Compensation

Reputational concerns are arguably the single most powerful incentive for board directors to act in the interest of shareholders. We propose a model to investigate the impact of boards’ reputational concerns on the level and structure of executive compensation, the use of camouaged pay, and the relation between board independence and compensation decisions. We show that, in order to be perceived as independent, boards lower managers’ pay, but may also pay managers in hidden ways or structure compensation ineciently. Interestingly, independent boards, not manager-friendly boards, are more likely to make use of hidden compensation. We apply our model to study the costs and benets of greater pay transparency and of measures, such as say-on-pay initiatives, that

Does tax policy affect executive compensation? Evidence from postwar tax reforms

The trends in executive pay and labor income tax rates since the 1940s suggest a high elasticity of taxable income with respect to tax policy. By contrast, the level and structure of executive compensation have been largely unresponsive to tax incentives since the 1980s. However, the relative tax advantage of different forms of pay was small during this period. Using a sample of top executives in large firms from 1946 to 2005, we also find a small short run response of salaries, qualified stock options, and bonuses paid after retirement to changes in tax rates on labor income — even though tax rates were significantly higher and more heterogeneous across individuals in the first several decades following WWII. We explore several potential explanations for the conflicting impressions given by the long-run and short-run correlations between taxes and pay, including changes in social norms and concerns about pay equality.

What Death can Tell: Are Executives Paid for Their Contributions to Firm Value?

Using stock price reactions to sudden deaths of executives as a measure of expected contribution to shareholder value, we provide empirical evidence on the relationship between executive pay and managerial contribution to shareholder value. We find, first, that the managerial labor market is characterized by positive sorting: managers with high contributions to shareholder value obtain higher pay. We estimate, second, that an average executive appears to retain 70% to 80% of the marginal rent from the firm-manager relationship. Overall, our study provides an estimate of rent sharing that is informative for the ongoing discussion about the level of executive compensation.

Institutional Investors, Managerial Ownership, and Executive Compensation

We examine the association between executive compensation and the interaction between the top-five institutional investor ownership and managerial ownership. We find that top-five institutional investors' ownership is more positively associated with pay-for-performance for small managerial ownership group than large managerial ownership group. We find that top-five institutional investors' ownership is more negatively associated with level of executive compensation for small managerial ownership group than large managerial ownership group. Neither dedicated nor active institutional investors are associated with an additional decrease in the level of executive compensation for large managerial ownership firms. We find that the level of pay is negatively associated with a high level of managerial ownership for the period after 2002. Collectively, the evidence is consistent with the managerial power theory.

Accounting Conservatism and Executive Compensation

Using a firm-year measurement of accounting conservatism developed by Khan and Watts (2009), I find that accounting conservatism is positively related to the pay-for-performance sensitivity of executive compensation, negatively related to the level of executive compensation. These empirical findings are robust after controlling, size, performance, risk, growth opportunities, firm age, capital expenditure institutional ownership and corporate governance. The results suggest that accounting conservatism can facilitate linking shareholders’ wealth to managers’ wealth and are consistent with the view that accounting conservatism reduces information asymmetry and enhance corporate governance. I also find significant differences in firms’ stock returns across the portfolios formed on the level of conservatism and the pay-for performance sensitivity of executive compensation. This finding indicates that accounting conservatism may play a role in stock valuation.

Public Opinion and Executive Compensation

We investigate whether public opinion influences the level and structure of executive compensation. During 1992–2008, the negativity of press coverage of chief executive officer (CEO) pay varied significantly, with stock options being the most criticized pay component. We find that after more negative press coverage of CEO pay, firms reduce option grants and increase less contentious types of pay such as salary, although overall compensation does not change. The reduction in option pay after increased press negativity is more pronounced when firms, CEOs, and boards have stronger reputation concerns. Our within-firm, within-year identification shows the results cannot be explained by annual changes in accounting rules regarding executive compensation, stock market conditions, or pay mean reversion. This paper was accepted by Brad Barber, finance.

‘Say on Pay’ Design and its Repercussion on CEO Investment Incentives, Compensation, and Firm Profit

We investigate experimentally how the enforcement of negative say on pay (SoP) votes affects a CEO’s investment incentives, the level and structure of executive compensation, and firm performance. We operationalize the board’s discretion in response to a no-vote via three levels of SoP enforcement. Boards in our experiment either (i) neglect the vote and never adjust CEO compensation (no enforcement), (ii) enforce the vote and always adjust CEO compensation in accord with the vote (unconditional enforcement), or (iii) enforce the vote and adjust CEO compensation only when the firm performs poorly (conditional enforcement). We find that the unconditional enforcement of no-votes is an effective instrument to curb rents of powerful CEOs. However, it also creates a hold-up problem that undermines CEOs’ investment incentives and firm profit. Conversely, the conditional enforcement of SoP votes eliminates the hold-up problem and improves the pay-for-performance relation, but has no effect on firm profit. We also find that the non-enforcement of SoP votes increases CEO compensation without affecting firm profit. These negative effects of an unconditional enforcement of SoP votes remain robust when participants interact repeatedly and/or when shareholders communicate “acceptable” bonus levels to CEOs. Our results inform regulators and boards of directors on the externalities and the potential cost that may arise when negative SoP votes are enforced mechanically.

The Effect of Insider Control and Global Benchmarks on Chinese Executive Compensation

ABSTRACTManuscript Type: EmpiricalResearch Question/Issue: We investigate the effect of insider control from the managerial power perspective and the global pay benchmarks from the behavioral approach on Chinese executive compensation.Research Findings: Based on a balanced panel sample of 502 Chinese listed firms between 2001 and 2006, we find that both CEO duality and CEO ownership exert significant influence on Chinese executive compensation contracting and they contribute to the high level of executive compensation. We support the managerial power hypothesis by arguing that CEO duality and CEO shareholding tend to entrench insider managers further to collude with government officials and extract a firm's assets. Shareholdings appear to actively restrain managers from serving their self‐interests as to their pay levels, including on the board independence and the supervisory board levels. However, private institutional shareholdings perform actively in restraining managerial influence on the executive pay setting. There is an upward increase in the executive pay levels due to the global pay benchmark effects introduced by foreign investment. The compensation committees' decisions on executive pay levels are largely influenced by the global peer group's pay levels, rather than linking to firm performance as predicted by the optimal contracting model.Theoretical Implications: We extend the optimal contracting model by incorporating the managerial power hypothesis to demonstrate how insider control affects the Chinese executive pay setting. We also add a behavioral approach to reflect how the global pay benchmarks affect the Chinese executive compensation setting via the negotiation between a firm's compensation committee and its managers.Practitioner/Policy Implications: The Chinese government should consider exerting rigorous restrictions on executive shareholding and management buy‐out as an incentive for managers. In addition, the Chinese Code of Corporate Governance should explicitly restrict CEO duality. The government should be aware of the potential influence of behavioral bias in human decisions departing from rational economical criteria, and set policies to balance the benefits of introduction of foreign investment against the costs of resultant excessive executive compensation, and the benefits of setting a compensation committee as a corporate governance control device against the costs of the compensation committees working with the executives together to increase the executive pay level.

The Public Perception and Normative Valuation of Executive Compensation: An International Comparison

This paper describes individuals' perceptions and normative valuations of executive compensation using comparable survey data for fifteen OECD member countries. An overwhelming majority of individuals (more than 90%) believes that top executives earn more than they actually deserve. However, there is also substantial variation in the actual and ethical levels of executive compensation, both within and across countries. The empirical analysis further shows that subjective estimates of executive pay are associated with objective measures of inequality and redistribution, and that individuals' perceptions and normative valuations of executive compensation are associated with their more general political preferences.

(The Executive Compensation System in Financial Corporations)

Korean Abstract: 본 연구의 목적은 금융기업 경영진의 보수체계의 현실과 문제점을 살펴보고 그에 대한 원인분석과 효과적인 해결책 제시에 있다. 글로벌 금융위기가 장기화되고 있는 오늘날의 상황에서, 사실상 사명감과 책임의식을 가지고 위기극복에 앞장서야 할 국내외의 금융기업 경영자들은 여전히 단기성과 위주의 보너스 및 성과급을 과다 지급하는 등 비도덕적 관행을 고수하고 있다. 본 연구에서는 이러한 금융기관의 경영부실화 사태 및 경영자들의 도덕적 해이의 업무행태의 원인에 대하여 크게 네 가지 사항을 제시하고, 현재의 미흡하고 불완전한 현재의 보상체계를 보완할 수 있는 효과적인 해결책을 제시하기 위해 삼성카드의 사례를 분석하였다. 그러나 본 연구에서는 2008년의 국내 금융기업 10곳의 경영진의 보수를 조사한 결과 비금융기업들에 비해 금융기업이 비교적 낮은 수준의 경영진 보수를 지급한 것으로 밝혀져, 금융기업의 고임금 문제현황을 다루고 있는 기존의 국외연구와는 사뭇 다른 결과를 나타냈다. 이는 본 연구에서 스톡옵션 지급액은 고려하지 않고 현금지급액만을 기준으로 경영진 보수를 산정했기 때문으로 보이며, 앞으로의 연구에서는 스톡옵션에 대한 연구가 추가적으로 진행되어야 할 것으로 보인다. English Abstract: The purpose of this study is to examine the current problematic executive compensation system in financial corporations, to analyze the causes of the situation, and to propose some effective solutions. Even though the managers of financial corporations are often expected to take the initiative to take a lead in overcoming the current global financial crisis, they are still sticking to excessive and short-term performance based incentives by shirking their sense of mission and responsibility. In this study, we suggest four major factors of the rampant malpractice of financial corporations, and perform a case analysis of Sam Sung Card to propose a key solution to make up for the weak points of the current incomplete compensation system. Unfortunately, we were however unable to observe the high executive compensation level as suggested by previous studies. The compensation level of ten Korean financial corporations for the year 2008 is similar or lower than those of non-financial corporations. It is likely that the result might have been under-calculated by only focusing on compensation paid in cash and not considering the amount of stock options. Thus, stock options paid to the managers of financial corporations should be included in any further research.

A perspective on regulatory paradigms: The case of IRS and Sarbanes-Oxley approaches to executive compensation-related regulation

In this paper we explore two regulatory paradigms, with an emphasis on the regulation of executive compensation. An example of the traditional rule-based paradigm is Internal Revenue Code Section 162(m) in which a tax-deductible cap was passed into law to limit executive compensation. We demonstrate that this approach yielded mixed results. While stronger pay/performance sensitivity has been documented, Section 162(m) appears to have actually exacerbated the level of executive compensation. We contrast the rules-based paradigm with an alternative paradigm illustrated by the Sarbanes-Oxley Act in which the US Congress introduced a series of corporate governance initiatives into federal securities law. The transformation of the mode of regulatory intervention as reflected by SOX is shown to be fully consistent with recent changes in the generally accepted conceptual framework for financial reporting.

Economic, Moral, and Motivational Criteria of Executive Compensation: Recent Developments

Recent economic developments have renewed societal debate about executive compensation practices in business organizations. This study explores economic, moral, and motivational criteria in decisions about how to best compensate executives in organizations. The essay devotes particular attention to new developments in this controversial debate. The authors propose that managerial work implies a kind of fiduciary trust necessary for the proper functioning of business activity and argue that executive compensation decisions and levels should be based on objective criteria.

The myth of executive compensation: do shareholders get what they pay for?

We use compensation data for a sample of 701 US public firms and document a significant positive relation between the level of executive compensation and the subsequent realized stock returns. In present value terms, shareholders in firms incurring a total compensation cost of $78 million above the median experience subsequent incremental wealth gains of $385 million above the median over the 5-year period following compensation awards. The results are robust to the use of size and industry-adjusted measures of compensation and returns, and hold after we segment the sample by firm size and industry. Our evidence is consistent with rational executive labour markets where more talented executives command higher compensation and produce superior returns.