Thursday, September 16, 2004

Stanley looks at CEO pay when other CEOs are on the Compensation Committee

The basic question that is being asked is "Does having CEOs of other firms on your compensation committee impact CEO pay at your firm?"

As author Brooke Stanley puts it: "Since the compensation of any given CEO is a function of the compensation of his peers, when one CEO serves on another's Compensation Committee, he has an opportunity to indirectly influence his own compensation by awarding increases in pay. Thus CEOs have both an incentive to drive up the compensation of other CEOs, as well as an opportunity to do so when they serve on the Compensation Committees of other firms."

The key point of this is the assumption that CEO pay is partially driven by how much peer firms pay their CEOs. Empirically this does appear to be the case. That is, at least indirectly paying any CEO more money may be expected to have a positive impact on all CEOs pay. Not surprisingly the tightest connection is seen at peer firms.
(To make a sports analogy, higher salaries for right fielders may indirectly drive up second basemen salaries, but a much stronger connection would be to say that higher right fielder salaries lead to still other right fielders getting higher pay.)

This paper examines a relatively small sample (n=94) of large firms from 1994 to 2001 to test whether CEOs do pay fellow CEOs more. If this is found to be the case, then it takes but a small mental jump to conclude that this payment could be the result of an incentive to raise the average CEO pay, and by extension, their own pay.

Using a model that tries to control for firm specific factors, Stanley finds that overall having the CEO of another firm on the compensation committee does not appear to lead to higher pay. An important exception to this is if the CEO is from a "peer firm." In this case pay does increase.

In the author's words: "Overall my results suggest that there is no opportunism in pay setting when a CEO serves on the Compensation Committee of another CEO, unless he is the executive of a peer firm, one similar in size. In such a case, both cash and total compensation are higher, supporting the hypothesis that an agency conflict exists when peers serve as monitors."

Interesting! I would wager that this relation is even more pronounced at small firms where peer relations likely play a more important role in pay setting.

BTW With this paper we can say our trip to the FMA meetings in New Orleans has officially begun. I will try to pick out several articles that will be presented at this year's conference (always one of my favorites!). We will have everything but the French Quarter, water, and too cold of meeting rooms! ;)

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