Wednesday, September 12, 2012

CEO pay in the FTSE 100

English: Differences in national income equali...
English: Differences in national income equality around the world as measured by the national Gini coefficient. The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income, and everyone else has zero income). (Photo credit: Wikipedia)
CEO Pay in FTSE 100: Pay Inequality, Board Size and Performance by William Forbes :: SSRN:

Still more evidence that suggests that excessive Executive pay hurts shareholders.  Unlike previous work this looks at more executives and at non-US data. 

Too high of executive compensation negatively affects stockholders of US firms was shown by Bebchuk, Martijn, and Peyers JFE 2011) who showed

"that corporate value, as proxied by Tobin’s Q, post- earnings announcement share price responses, shareholder responses to acquisitions and executive turnover all deteriorate in the CEO pay slice rises. This suggests a high CPS may reflect something other than a reasonable re- ward for services rendered to company shareholders"    

Now Forbes and Pogue  extend the work of team Bebchuk by going beyond the pay of the top 5 executives as well as looking at UK firms.

Their Verdict? 

Excessive Executive pay is still detrimental:

"...additional evidence on the Bebchuk et al hypothesis that a higher CPS damages company performance from outside the US....While much of the debate concerning managerial “power” to set their own pay has been US based Conyon et al ( Conyon (2011)) have shown that, controlling for risk, UK and US CEO pay levels are not as different as had previously been assumed."

BTW you should definitely be aware of the Gini Measure, it looks worse than it really is (key to remember it is a measure of inequality in pay (or wealth etc in other fields).  Again quoting :

"The Gini coefficient (G) is then the ratio of the difference between the 45◦ line of absolute equality and the curve denoting the actual, unequal, distribution to the total area lying beneath the line of equality. While the Gini coefficient has various mathematical representations it turns out to be simply one half of the relative mean difference, defined as the arithmetic average of the absolute value differences, between all pairs of incomes.
nn G=(1/2n2μ)SUM SUM |yi −yj|
i=1 j=1 nn
= 1 − (1/n2 μ) 􏰀 􏰀 M in(yi , yj ) i=1 j=1
= 1 + (1/n) − (2/n2μ)[y1 + 2y2 + ..... + nyn] for y1 ≥y2 ≥....≥yn.    (1)
where μ is the average level of income across members of the group (say a company board) and n is the size of the population (or board size)."


"In this paper we examine the agency costs of seemingly excessive pay awards to CEO's within the FTSE 100 in the last decade. Are CEOs taking a large proportion of the total pot (a big "pay slice") more, or less, able to return value to shareholders by better management? In presenting this evidence we describe variations in whole distribution of executive pay, rather than invoking some arbitrary cut-off point (e.g. the CEO's pay as a percentage of their five highest paid peers or the CPS), to determine how changes in shareholder value match to concurrent changes in the distribution of executive pay. We ask is the impact of executive pay-inequality a function of board size, rendering the CPS measure problematic in this context? If so how does the interaction of board size and corporate performance size, as measured by shareholder returns, explain variation in the sensitivity of the pay-performance relationship for UK FTSE executives? We advance the Gini coefficient as a preferable measure of executive pay inequality in order to capture the impact of perceived inequality upon corporate performance."

Forbes, William Patrick, CEO Pay in FTSE 100: Pay Inequality, Board Size and Performance (September 1, 2012). Available at SSRN:
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