Pay at the executive suite: How do US banks compensate their top management teams?

This study examines how a large sample of US banks compensates their top management teams (i.e., the top four to five highest ranking executives in each bank). We observe two tiers of compensation in the executive suite: the Chief Executive Officer (CEO) and the rest of the top management team. CEOs receive not only greater pay in absolute dollar, but are also rewarded more in relation to performance, as manifested in having a larger portion of their pay in performance contingent compensation. Below the CEO, top executives have similar compensation structure and pay to performance elasticities. The results are robust to a significant size effect, and alternate measures of performance.     

CEO Pay and Corporate Governance in the U.S.: Perceptions,Facts, and Challenges

This article brings a broad range of statistical studies and evidence to bear on three common perceptions about the CEO compensation and governance of U.S. public companies: (1) CEOs are overpaid and their pay keeps increasing; (2) CEOs are not paid for their performance; and (3) boards do not penalize CEOs for poor performance. While average CEO pay increased substantially during the 1990s, it has declined since then— by more than 30%—from peak levels that were reached around 2000. Moreover, when viewed relative to corporate net income or profits, CEO pay levels at S&P 500 companies are the lowest they've been in the last 20 years. And the ratio of large‐company CEO pay to firm market value is roughly similar to its level in the late 1970s, and lower than the levels that prevailed before the 1960s. What's more, in studies that begin with the late '70s, private company executives have seen their pay increase by at least as much as public companies. And when set against the compensation of other highly paid groups, today's levels of CEO pay, although somewhat above their long‐term historical average, are about the same as their average levels in the early 1990s. At the same time, the pay of U.S. CEOs appears to be reasonably highly correlated with corporate performance. As evidence, the author cites a 2010 study reporting that, over the period 1992 to 2005, companies with CEOs in the top quintile (top 20%) of realized pay in any given year had generated stock returns that were 60% higher than the average companies in their industries over the previous three years. Conversely, companies with CEOs in the bottom quintile of realized pay underperformed their industries by almost 20% in the previous three years. And along with lower pay, the CEOs of poorly performing companies in the 2000s faced a significant increase in the likelihood of dismissal by their own boards. When viewed together, these findings suggest that corporate boards have done a reasonably good job of overseeing CEO pay, and that factors such as technological advances and increased scale have played meaningful roles in driving the pay of both CEOs and others with top incomes—people who are assumed to have comparable skills, experience, and opportunities. If one wants to use increases in CEO pay as evidence of managerial power or “board capture,” one also has to explain why the other professional groups have experienced similar, or even higher, growth in pay. A more straightforward interpretation of the evidence reviewed in this article is that the market for talent has driven a meaningful portion of the increase in pay at the top. Consistent with this conclusion, top executive pay policies at roughly 97% of S&P 500 and Russell 3000 companies received majority shareholder support in the Dodd‐Frank mandated “Say‐on‐Pay” votes in 2011 and 2012, the first two years the measure was in force.     

The Relationship between Shareholder Return and CEO Pay over a CEO's Full Period of Service

The author reports the findings of his examination of the relationship between CEO pay and performance, as measured by shareholder returns, using measures of compensation and returns that span a CEO's full period of service. Unlike studies that look at annual measures of CEO pay and stock returns—which are distorted by the widespread use of options and the arbitrary effects of when CEOs choose to exercise their options—the author finds a statistically significant connection between total compensation and shareholder return measured over full periods of service for 521 S&P 500 CEOs. Indeed, after one adjusts for differences in the length of a CEO's service, shareholder return is arguably the most important determinant of variation in the amount paid CEOs over their complete tenures. Besides answering the legion of critics of CEO pay, the author's analysis refutes the claim that bull markets are the main force driving executive pay by demonstrating that the increases in career pay attributable to increases in shareholder returns are almost exactly offset by reductions in pay when the Value‐Weighted (S&P 500) Index increases by the same amount. In other words, CEOs’ cumulative career pay is effectively driven by the extent to which their stock returns outperform the broad market. The analysis also casts doubt on the popular claim that the link between CEO pay and corporate size provides incentives to undertake even value‐reducing acquisitions to boost size. As the author's analysis shows, the estimated losses in career CEO pay associated with even small declines in shareholder returns are likely to be offset by the pay increases attributable to size.     

Who should set CEO pay? The press? Congress? Shareholders?

Populist fervor in an election year has transformed executive compensation from a business issue into a political one. Critics, led by Graef Crystal, author of In Search of Excess: The Overcompensation of American Executives, charge that CEOs are ripping off shareholders with their outrageous salaries while running U.S. corporations into the ground. Politicians claim overpaid CEOs are the root cause of the U.S. competitiveness problem. Add a recessionary business climate to the fact that some CEOs earn 130 times more than their lowest paid employees, and you have the makings of a populist rebellion. In a bid to appease voters, Congress is considering several bills that would limit the deductibility of "excessive executive salaries," the SEC has opened the issue to shareholder comment, and the Financial Accounting Standards Board is looking at new accounting standards for granting stock options to executives as part of company compensation schemes. Andrew R. Brownstein and Morris J. Panner say it's time to put the debate back where it belongs--in a business context. The real question is not are executives paid too much, but are shareholders getting their money's worth. Most U.S. corporations use stock compensation to link company long-term performance to executive salaries. And because of the staggering market performance of U.S. corporations in the 1980s, an overwhelming majority of CEOs are actually paid in line with their performance. Rather than cut executive pay, Brownstein and Panner suggest that corporations extend incentive-based compensation plans to all employees, thus narrowing the salary gap and establishing pay for performance at every level of the organization.     

CEO Incentives—It's Not How Much You Pay,But How*

In this 1990 Harvard Business Review classic, the authors begin by correcting a number of widespread misconceptions:

• • Contrary to headlines at the time, top executives at the end of the 1980s were not receiving record salaries and bonuses. Instead they were catching up to real levels of pay that prevailed during the 1930s and had dropped sharply since then.
• • Annual changes in executive compensation during the 1970s and 1980s were largely unrelated to changes in corporate performance, with CEO total compensation varying by only about $3 with every $1,000 change in shareholder wealth. (And the variability of total CEO pay was no higher than that of the compensation of hourly and salaried employees.)
• • With respect to pay for performance, U.S. compensation practices in the '70s and '80s were getting worse rather than better over time. The percentage of stock ownership by CEOs in large public companies was ten times greater in the 1930s than in the 1980s. And during the previous 15 years (1975-1989), CEO holdings as a fraction of value had actually fallen.

With the aim of reversing these trends, the authors offered three recommendations:

• • Substantial equity ownership by CEOs.
• • Structuring of cash compensation to provide big rewards for outstanding performance and meaningful penalties for poor performance.
• • Increased threat of dismissal for poor performance.

Since publication of this article in 1990, the first and third of these goals have largely been accomplished (while the second has proved more elusive).     

Does Say‐on‐Pay Matter? Evidence from Say‐on‐Pay Proposals in the United States

We investigate the effect of say‐on‐pay (SOP) proposals on changes in executive and director compensation. Relative to non‐SOP firms, SOP firms’ total compensation to CEOs does not significantly change after the proposal. However, the mix of compensation does change—companies move away from using cash compensation toward more incentive compensation, offsetting the reduction in bonus. Further, the mix of compensation of non‐CEO executives changes similarly to that of CEOs. Compensation to directors of SOP firms increases less than non‐SOP firms. Firms whose CEOs are well compensated, especially with cash‐based compensation, are most likely to receive a proposal.     

CEO prior uncertainty and pay–performance sensitivity

A CEO's pay–performance sensitivity (PPS) is higher in the first year of their tenure than in the following years. I explain this finding with reference to chief executive officer (CEO) prior uncertainty: Because of information asymmetry and/or uncertainty about the quality of the match between a CEO and a firm, first-year compensation is often arranged to depend largely on performance. Consistent with this explanation, CEOs with higher prior uncertainty exhibit higher first-year PPS. Also, PPS is higher for outsider CEOs than insider CEOs. Among outsider CEOs, first-year PPS is lower for former executives of large public firms. An insider CEO's service time in a firm before becoming the CEO reduces first-year PPS.     

Executive pensions,disclosure quality,and rent extraction

We argue that vague disclosure of supplemental executive retirement plans (SERPs) may impede effective shareholder monitoring over this compensation form. Hence, CEOs with power over the board may view SERP benefits as an attractive mechanism to increase their own pay, thereby extracting rents. Our results provide empirical support of the hypothesis. Many of the variables proxying for CEO power are significant in explaining the incidence and magnitude of CEO SERP benefits. In contrast, we find little association between CEO power and cash pay, a well disclosed and monitored compensation form. The results indicate that rent extraction depends on the quality of compensation disclosure.     

CEO excess compensation: The impact of firm size and managerial power

Chief executive officer (CEO) compensation has received a great deal of attention over the past several decades. Critics assert that CEO compensation is “excessive” because it is only weakly linked to firm performance (i.e., managerial rent-extraction). On the other hand, defenders suggest that CEO compensation is “justified” given the incremental shareholder wealth created by CEOs, or that large CEO compensation packages merely reflect labor market forces. Prior research documents that CEO power and firm size are associated with larger compensation, but providing evidence that the larger compensation is excessive (i.e., not economically justified) has proven difficult. For each test firm we identify a potential replacement CEO (i.e., an executive-specific, within-country (US) compensation benchmark) and create an empirical test of excess compensation. We also examine the possibility that excess compensation is conditional upon firm size or CEO power. In spite of an inherent bias against finding excess compensation, the results suggest that the most powerful CEOs receive compensation that is not economically justified. We find no evidence of CEO excess compensation in the largest firms.     

GOLF TOURNAMENTS AND CEO PAY—UNRAVELING THE MYSTERIES OF EXECUTIVE COMPENSATION

Leading financial economists and activist institutional investors have long argued that the proper alignment of manager and shareholder interests requires the use of performance based compensation. Partly in response to these pressures, and in combination with a change in the tax code that encourages performance-based pay, corporate boards have dramatically increased their use of stock grants and executive stock options. Combine this development with the longest bull market in U.S. financial history, and the result is unprecedented levels of CEO pay at the close of the 20th century. This review of executive compensation reveals that the economic theory of tournaments may provide a rationale for the pattern, if not the level, of executive pay. Specifically it finds that the total compensation of the five highestpaid executives in a cross-section of new and old-economy firms is very similar to the pattern of payouts to players in a golf tournament. The author also reports that recent studies show a significant increase in the pay-for-performance correlation throughout the 1990s. But whether that correlation is as high as it should be, and whether current levels of CEO pay are socially "optimal," are questions that remain unanswered.     

CEO DIRECTORS,EXECUTIVE INCENTIVES,AND CORPORATE STRATEGIC INITIATIVES

I study how directors who are chief executive officers (CEOs) of other firms affect board effectiveness. I find that CEOs are paid more and their compensation is less sensitive to firm performance when other CEOs serve as directors. This is not an employment risk premium because CEO directors are not associated with higher turnover‐performance sensitivity. Also, CEO directors have no effect on corporate innovation but are associated with higher acquisition returns, especially for complex deals. My results suggest that the advisory benefits of CEO directors must be balanced against the distortions in executive incentives associated with their board service.     

What's wrong with executive compensation? A roundtable moderated by Charles Elson

The value that many superpaid CEO superstars supposedly created has largely disappeared, and the likelihood that it will be recovered anytime soon seems remote. On top of that, a good number of top executives treated their companies like ATMs, awarding themselves millions of dollars in corporate perks. It's hard to dispute the idea that executives were corrupted by the sums of money dangled in front of them. What's wrong with executive compensation, and what can we do about it? HBR and the University of Delaware's Center for Corporate Governance convened a round-table of compensation experts last October on the university's campus in Newark, Delaware. The 12 panelists, from CEOs to investors, from the professionals who advise them to a chief justice who rules on their disputes, provided an extraordinary diversity of viewpoints. The panelist began by debating ways to align the interests of the senior executives with the long-term interests of the company-weighing the relative benefits of stock options versus stock grants, for instance. But the discussion expanded to cover broader questions of corporate governance and company values. "The main reason compensation increases every year is that most boards want their CEO to be in the top half of the CEO peer group," said Ed Woolard,Jr., a former CEO of DuPont. And compensation lawyer Joe Bachelder pointed out the danger of structuring pay in such a way that it dampens risk taking among executives. It was a lively and wide-ranging discussion of one business's most pressing issues.     

Bidder CEO and Other Executive Compensation in UK M&As

This paper investigates the impact of M&As on bidder (CEO and other) executive compensation employing a unique sample of 100 completed bids in the UK over the 1998–2001 period. Our findings indicate that less independent and larger boards award CEOs significantly higher bonuses and salary following M&A completion both for the full sample and for the UK and US sub‐samples. UK CEOs and executives are rewarded more for the effort exerted in accomplishing intra ‐ industry or large mergers than for diversifying or small mergers and their cash pay is unaffected by other measures of their managerial skill or performance. US bidders are rewarded at higher levels than their UK counterparts and their remuneration is related only to measures of CEO dominance over the board of directors. Overall our findings offer support for the managerial power rather than the agency theory perspective on managerial compensation.     

Should I stay or should I go? Former CEOs as monitors

In the German two-tiered system of corporate governance, it is not uncommon for chief executive officers (CEOs) to become the chairman of the supervisory board of the same firm upon retirement. This practice has been the subject of controversial debate because of potential conflicts of interest. As a member of the supervisory board, the former CEO must monitor his successor and former colleagues and is involved in setting their pay. We analyze a panel covering 150 listed firms over a 10-year period. Consistent with a leniency bias, we find evidence that firms in which a former CEO serves on the supervisory board pay their executives more. We further find weak evidence that the compensation of the members of the supervisory board is also higher. Short-run event study results indicate that the announcement of the transition of a retiring CEO to the supervisory board is considered good news. Thus, despite the increases in executive compensation we document, CEO transitions are not a cause of concern for shareholders.     

Are long-tenured CEOs rent seekers? Analysis of cash compensation and post disposal performance

Are typical long-tenured CEOs rent-seekers? Do compensation committees consider undiversified risk for veteran executives and design their cash pay to limit their risk exposure? Because an exit decision requires board approval, discontinued operations provide a unique setting to analyze intervention by compensation committees. Seasoned managers should require less oversight because their ability has been revealed over time. However, as CEOs advance in their careers, they are more likely to acquire power to influence board decisions. They are also more risk averse and potentially more myopic than younger CEOs because they hold a large undiversified portfolio. Lucrative labor markets for talented retired executives can incentivize long-tenured CEOs to maintain a solid reputation. I reexamine the previously reported differential sensitivity of CEO cash compensation to positive or negative-valued disposal decisions, which can be viewed as rent-seeking. I show that cash pay for veteran CEOs are shielded from the effect of both negative and positive-valued discontinued operations, suggesting that compensation committees alter their cash pay. This evidence does not support rent-seeking. I also find strong evidence that long-tenured CEOs make better exit decisions to improve future firm performance than less experienced executives.     

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.     

Boards,Executive Excess Compensation,and Shared Power: Evidence from Nonprofit Firms

We investigate how executives, the board, and excess compensation jointly affect the performance of nonprofits. Since the common measure of nonprofit performance often includes salaries, we also use expenses that directly benefit the targeted population. Our results suggest that above average compensation for executives is associated with poor firm performance. However, the negative relation of CEO pay to performance occurs for firms with only one executive, the CEO. We conclude that a powerful CEO with autonomy can harm firm performance, but other executives can mitigate these agency problems. The board also appears to monitor direct community benefits more than indirect benefits.     

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.     

Performance Incentives within Firms: The Effect of Managerial Responsibility

We show that top management incentives vary by responsibility. For oversight executives, pay‐performance incentives are $1.22 per thousand dollar increase in shareholder wealth higher than for divisional executives. For CEOs, incentives are $5.65 higher than for divisional executives. Incentives for the median top management team are substantial at $32.32. CEOs account for 42 to 58 percent of aggregate team incentives. For divisional executives, the pay–divisional performance sensitivity is positive and increasing in the precision of divisional performance and the pay–firm performance sensitivity is decreasing in the precision of divisional performance. These results support principal–agent models with multiple signals of managerial effort.     

Corporate performance and CEO compensation in China

This paper examines the compensation of CEOs in China's listed firms. First, we discuss what is known about the setting of CEO compensation and then we go on to examine factors that may help explain variations in the use of performance related pay. In China, listed firms have a dominant or controlling shareholder and we argue that the distinct types of controlling shareholder have different impacts on the use of incentive pay. We find that firms that have a State agency as the major shareholder do not appear to use performance related pay. In contrast, firms that have private blockholders or SOEs as their major shareholders relate the CEO's pay to increases in stockholders' wealth or increases in profitability. However the pay–performance sensitivities for CEOs are low and this raises questions about the effectiveness of firms' incentive systems.