Thursday, April 21, 2005

Six Degrees of Separation: Examining Back Door Links between Directors and CEO Pay - Knowledge@Wharton

Six Degrees of Separation: Examining Back Door Links between Directors and CEO Pay - Knowledge@Wharton

Forget 6 degrees of Kevin Bacon. Now we can play the game for real and see how CEOs and their boards are connected and how the connection impacts executive pay!

Executive Compenstaion is always an interesting topic and Larker, RIchardson, Tuna, and Seary have made it more so! They look for connections between CEOs and Board members across "22,074 directors for 3,114 firms, we develop a measure of the "back door" distance between each pair of directors on a company's board."

And they find? Drum roll please.....
"CEOs at firms where there is a relatively short back door distance between inside and outside directors or between the CEO and the members of the compensation committee earn substantially higher levels of total compensation (after controlling for standard economic determinants and other personal characteristics of the CEO and the structure for board of directors). This statistical association is consistent with recent claims that the monitoring ability of the board is hampered by “cozy” and possibly difficult toobserve relationships between directors."
I hope I would be as generous as the authors in maintaining that this could be justifiable:
"There could be innocuous explanations for the extra compensation, he says. The network of links among directors acts as a mechanism to disseminate information, and part of the information may be that a director impressed by the work of a compensation consultant at one company simply takes the template over to another, Richardson says, adding that yet another plausible explanation for the compensation differential could be that directors who serve on multiple boards "inherently are of a higher quality," and therefore the companies where they are directors generate greater value, and that greater value is reflected in the CEO's compensation." From McKinsey Quarterly.
Yeah. Or for the more cynical: Boards pay their "friends" more.

Two cites:

McKinsey Quarterly or from SSRN

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