Corporate governance, compensation consultants, and CEO pay levels

This study investigates the relation between corporate governance and CEO pay levels and the extent to which the higher pay found in firms using compensation consultants is related to governance differences. Using proxy statement disclosures from 2,110 companies, we find that CEO pay is higher in firms with weaker governance and that firms with weaker governance are more likely to use compensation consultants. CEO pay remains higher in clients of consulting firms even after controlling for economic determinants of compensation. However, when consultant users and non-users are matched on both economic and governance characteristics, differences in pay levels are not statistically significant, indicating that governance differences explain much of the higher pay in clients of compensation consultants. We find no support for claims that CEO pay is higher in potentially “conflicted” consultants that also offer additional non-compensation-related services.     

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.     

CEO compensation,family control,and institutional investors in Continental Europe

This paper investigates the impact of family control and institutional investors on CEO pay packages in Continental Europe, using a dataset of 754 listed firms with 3731 firm-year observations from 14 countries during 2001–2008. We find that family control curbs the level of CEO total and cash compensation, and the fraction of equity-based compensation. Moreover, we do not observe a significant effect of family control on the excess level of total and cash compensation. This evidence indicates that controlling families do not use CEO compensation to expropriate wealth from minority shareholders. We show that institutional ownership is associated with higher levels of CEO cash and total compensation in Continental Europe, especially in family firms. Also, foreign institutional investors have a positive and significant impact on CEO compensation level. Finally, results indicate that institutional investors affect CEO pay structure: they increase the use of equity-based compensation in both family and non-family firms.     

The effect of financial reporting quality on CEO compensation structure: Evidence from accounting comparability

This study examines the effect of accounting comparability on the design of CEO compensation structure. After controlling for firm-specific attributes, we find that accounting comparability is positively associated with CEO equity-based compensation intensity and pay-performance sensitivity. This suggests that the improved comparability increases the usefulness of equity-based compensation and a firm is willing to offer more equity-based compensation contracts to CEOs and increase their pay-performance sensitivity. Further, we find that the impact of comparability on the CEO’s compensation contract increases with information asymmetry, which is consistent with the notion that accounting comparability is a quality of financial reporting that facilitates the use of equity-based compensation in a poor information environment. Our analysis also reveals that the effect of accounting comparability on CEO compensation structure is greater when a firm’s corporate governance is strong, consistent with the complementary relation between comparability and the exiting corporate governance in determining CEO compensation schemes. Overall, our evidence suggests that firms utilize more equity-based compensation as a proportion of total compensation under greater accounting comparability and enhance the alignment between equity-based compensation and firm performance.     

An ill wind? Terrorist attacks and CEO compensation

Using multiple measures of attack proximity, we show that CEOs employed at firms located near terrorist attacks earn an average pay increase of 12% after the attack relative to CEOs at firms located far from attacks. CEOs at terrorist attack-proximate firms prefer cash-based compensation increases (e.g., salary and bonus) over equity-based compensation (e.g., options and stocks granted). The effect is causal and it is larger when the bargaining power of the CEO is high. Other executives and workers do not receive a terrorist attack premium.     

Non-uniform effects of CEO equity-based compensation on firm performance – An application of a panel threshold regression model

We use panel-data threshold models to examine the non-uniform relation between Chief Executive Officer (CEO) equity-based compensation and earnings-based performance. Prior studies examining this very issue have arbitrarily adopted various exogenous criteria to partition the sample, and thus the inferences could be misleading. To address this issue, we employ the threshold regression models that allow the data itself to endogenously generate several regimes identified by the thresholds. Our empirical results show that not only is the positive impact of CEO equity incentives on firm performance more pronounced for companies with lower and moderate levels of CEO stock-based incentive pay, but also for less-profitable firms. The results are consistent with the position that excessive equity-based awards are unable to benefit firm performance, and that share-based compensation is more effective for start-up firms with low profit.     

CEO compensation and future shareholder returns: Evidence from the London Stock Exchange

This study examines the ex-post consequences of CEO compensation for shareholder value. The main objective is to explore whether companies that pay their CEO excessive fees (in comparison to those of peer firms in the same industry and size group) generate superior future returns and better operating performance. Our analysis, which separately considers the cash-based and incentive/equity-based components of CEO compensation, is based on a large sample of UK-listed companies over the period 1998–2010. We find that CEO incentive pay is negatively associated with short-term subsequent returns. Interestingly, firms that pay their CEOs at the bottom of the incentive-pay distribution earn positive abnormal returns and, also, significantly outperform those at the top of the incentive-pay distribution. Further analysis reveals that such outperformance can be largely explained by the excessive exposure of low-incentive-pay firms to idiosyncratic risk. Finally, evidence from panel regressions suggests that, in addition to its negative relationship with returns, incentive pay is also inversely associated with future operating performance.     

Do corporate governance mechanisms influence CEO compensation? An empirical investigation of UK companies

The aim of this paper is to empirically examine the influence of corporate governance mechanisms, that is, ownership and board structure of companies, on the level of CEO compensation for a sample of 414 large UK companies for the fiscal year 2003/2004. The results show that measures of board and ownership structures explain a significant amount of cross-sectional variation in the total CEO compensation, which is the sum of cash and equity-based compensation, after controlling other firm characteristics. We find that firms with larger board size and a higher proportion of non-executive directors on their boards pay their CEOs higher compensation, suggesting that non-executive directors are not more efficient in monitoring than executive directors. We also find that institutional ownership and block-holder ownership have a significant and negative impact on CEO compensation. Our results are consistent with the existence of active monitoring by block-holders and institutional shareholders. Finally, the results show that CEO compensation is lower when the directors’ ownership is higher.     

How Firms Use Director Networks in Setting CEO Pay

We examine how firms use the network of overlapping directorships to determine chief executive officer (CEO) compensation. We contribute to related work by empirically exploring two competing hypotheses. In the first hypothesis, networks propagate relevant information used to establish good pay practices. In the second hypothesis, director networks are used opportunistically to benefit the CEO. The empirical findings are generally consistent with the first hypothesis. Yet, the importance of director networks is reduced when the CEO is entrenched and when management hires a compensation consultant. The latter finding is especially pronounced when director networks predict a reduction in CEO pay.     

Ex ante CEO severance pay and risk-taking in the financial services sector

We examine 533 CEO severance contracts for financial services firms from 1997 to 2007 and find that ex ante severance pay is positively associated with risk-taking after controlling for the incentive effects provided by equity-based compensation. We report a positive causal relation between the amount of severance pay and risk-taking using popular market-based risk measures as well as the distance-to-default and the Z-score. We also find that severance pay encourages excessive risk-taking using metrics such as tail risk and asset quality. Our results are consistent with the risk-shifting argument and provide support for recent reforms on severance pay in the financial sector.     

Director compensation incentives and acquisition performance

This paper investigates the relation between director compensation structure and shareholder interests in the context of acquisitions. Our evidence suggests that acquirer firms that compensate their directors with a higher proportion of incentive-based compensation have significantly higher stock returns around the announcement. Compared to acquirers in the low equity-based compensation group, acquirers in the high equity-based compensation group outperform by 9.54% in a five-day period surrounding the announcement date. These results hold even after controlling for endogeneity issues. We further find that acquirers with higher equity-based pay exhibit greater improvements in stock price and operating performance in the three years following acquisitions. An increase in director equity-based pay also results in a lower acquisition premium for targets. These results indicate that equity-based compensation provides incentives for directors to make decisions that meet the interests of shareholders.     

The timing of changes in CEO compensation from cash bonus to equity-based compensation: Determinants and performance consequences

This study examines the determinants and performance consequences of changes in CEO compensation structure. The study uses the unique setting when Australian companies have changed from cash bonus to equity-based compensation. While most US CEOs receive some form of equity-based compensation, Australian CEOs have not always been paid equity-based compensation. According to efficient contracting theories, we argue that the change to equity-based compensation is driven by changes in firm characteristics and by the occurrence of CEO turnover, the latter of which provides a less costly opportunity for such change. Our results are consistent with the above arguments. We also document a significant negative association between changes in compensation structure and subsequent firm performance in the following year, even after controlling for CEO turnover and poor governance environments. Overall, our results suggest that the initial change to equity-based compensation is part of an error learning process made by firms that leads them towards efficient CEO compensation contracts.     

Non-compensation-related consultant service and CEO compensation

This study examines how consultants’ non-compensation-related consulting service (NCS) affects the contractual usefulness of accounting and stock information in executive compensation, as reflected in pay-performance sensitivity. The hypothesis is based on anecdotal evidence suggesting that consultants’ provision of NCS is likely to adversely affect the quality of CEO compensation plans. We investigate whether the consultants providing NCS are involved in potential conflicts of interest. The results show that CEO pay is higher in companies where consultants provide NCS and have a higher NCS fee ratio. The pay-performance sensitivity in CEO compensation decreases when consultants engage in NCS. The overall results are consistent with NCS representing a conflict of interest and compromising the quality of compensation committees.     

Executive compensation and internal capital market efficiency

We document that chief executive officer (CEO) incentive compensation plays an important role in determining internal capital market (ICM) allocation efficiency. Our results suggest that CEO equity-based compensation can be effective in ameliorating inefficiencies in internal capital allocation decisions. We find that while stock grants play an important role in motivating CEOs to make more efficient internal capital allocation decisions, there is surprisingly no discernible influence of stock options. Our analysis supports the view that private benefits derived by managers are increasing in internal capital misallocation. We also document a strong positive link between CEO incentive compensation and excess value of diversified firms suggesting that the diversification discount can be ameliorated with CEO incentive compensation. The study contributes to the ICM literature and the literature on conglomerate diversification discount.     

CEO compensation contagion: Evidence from an exogenous shock

We examine how Chief Executive Officer (CEO) compensation increased at a subset of firms in response to a governance shock that affected compensation levels at other firms in the economy. We first show that Delaware-incorporated firms with staggered boards and no outside blockholders increased CEO compensation following the mid-1990s Delaware legal cases that strengthened their ability to resist hostile takeovers. Consistent with the Gabaix and Landier (2008) contagion hypothesis, non-Delaware firms subsequently increased CEO compensation when the rulings affected a substantial number of firms in their industries. We further show how these legal developments contributed significantly to the rapid increase in CEO compensation in the late 1990s.     

Compensation discussion and analysis (CD&A): Readability and management obfuscation

This paper examines the relationship between the readability of the CD&A section in proxy statements and management motives to obfuscate executive compensation disclosures. Using the CD&As in the 2007 and 2008 proxy statements, we examine whether the CD&A readability is associated with the proportion of CEO pay not related to the economic determinants of compensation. We note that the average CD&A is difficult to read. We find that firms with CEO pay exceeding the benchmark pay have a more difficult to read CD&A in the 2007 proxy season. The result suggests that, in its first CD&A report, top management tends to cloak its compensation practices when the practices are not tied to the economic determinants of pay. However, we also find those firms with CEO pay exceeding the benchmark pay improve the readability of their CD&As in the 2008 proxy season, suggesting that executive compensation disclosure improves under regulatory oversight and public pressure.     

CEO Compensation and Firm Performance: an Empirical Investigation of UK Panel Data

This paper examines the link between CEO pay and performance employing a unique, hand‐collected panel data set of 390 UK non‐financial firms from the FTSE All Share Index for the period 1999–2005. We include both cash (salary and bonus) and equity‐based (stock options and long‐term incentive plans) components of CEO compensation, and CEO wealth based on share holdings, stock option and stock awards holdings in our analysis. In addition, we control for a comprehensive set of corporate governance variables. The empirical results show that in comparison to the previous findings for US CEOs, pay‐performance elasticity for UK CEOs seems to be lower; pay‐performance elasticity for UK CEOs is 0.075 (0.095) for cash compensation (total direct compensation), indicating that a ten percentage increase in shareholder return corresponds to an increase of 0.75% (0.95%) in cash (total direct) compensation. We also find that both the median share holdings and stock‐based pay‐performance sensitivity are lower for UK CEOs when we compare our findings with the previous findings for US CEOs. Thus, our results suggest that corporate governance reports in the UK, such as the Greenbury Report (1995) that proposed CEO compensation be more closely linked to performance, have not been totally effective. Our findings also indicate that institutional ownership has a positive and significant influence on CEO pay‐performance sensitivity of option grants. Finally, we find that longer CEO tenure is associated with lower pay‐performance sensitivity of option grants suggesting the entrenchment effect of CEO tenure.     

Are more able CEOs getting more compensated? Evidence from the pay-for-performance sensitivity of equity-based incentives

This study investigates whether the managerial ability of a chief executive officer (CEO) is associated with the CEO's pay-for-performance sensitivity (PPS) of the equity-based compensation. We predict that more talented CEOs receive a higher PPS of equity incentives. Using the managerial ability score (Demerjian, Lev, & McVay, 2012) and PPS measures of options and stocks (Core & Guay, 1999), we find that a CEO's PPS of the equity-based compensation is significantly increasing in the CEO's ability. We also find that the association between managerial ability and the PPS of stock incentives is more evident for small firms. Furthermore, our results show that high ability CEOs are associated with a steeper PPS of option incentives, especially when they are not near retirement. Together, our findings suggest that firms generally incorporate the relative efficiency factor of CEO's ability in designing the CEO's equity-based compensation contracts, and thus the cross-sectional variation in the CEO's PPS is positively influenced by the CEO's ability.Data availability: Data used in this study are available from public sources identified in the study.     

Does shareholder approval requirement of equity compensation plans matter?

This paper studies the impact of the 2003 SEC Regulation requiring shareholder approval of all equity-based executive compensation plans on executive compensation policies and practices at S&P 500 firms. Following the 2003 Regulation, firms with shareholder approved equity plans in place or those with strong performance, while not those with non-approved plans or weak performance, increase their equity compensation proposal submission activity. The quality of equity compensation proposals improves in the after-regulation period, and shareholders exhibit greater scrutiny and monitoring of executive compensation through increased voting rights. We find a decline in the equity pay component while an increase in the cash component of total executive compensation after the 2003 Regulation and also provide evidence that the 2003 Regulation contributes to this change in compensation structure.     

Bankers' compensation and fair value accounting

This paper examines the role of certain fair value accounting (FVA) outcomes in compensation of US bank CEOs. The use of FVA in compensation invites an agency cost—the clawback problem—if cash compensation is based on unrealized profits that may reverse in the future. At the same time FVA may be a good measure of current managerial effort and so be cash compensated. We find evidence consistent with a positive link between CEO cash bonus and fair value (FV) valuation of trading assets, managed for short-term profit, as well as (amongst banks with limited trading exposure) a positive link between CEO pay and FV valuations of available for sale (AFS) assets. We find no evidence that trading income is incrementally compensation relevant, indicating that compensation committees avoided the clawback problem for unrealized trading gains. The paper also provides evidence on the link between FVA outcomes and equity-based pay.