Issues in Managerial Compensation Research

[Excerpt] Compensation is at the core of any employment exchange (Milkovich & Newman, 1993; Simon, 1951). It is probably the most basic reason people agree to become employees and it serves as a defining characteristic of any employment relationship (March & Simon, 1958). Recently, managers have been bombarded with a profusion of ways to pay employees. There is team-based pay, broad-banding, pay at risk, paying for competencies, paying for skills, and even The New pay. Understanding which of these have the potential to add value and which are relatively more effective is a tough task, like untying the Gordian knot. Rather than simply cutting through the problem (Alexander the Great\u27s tack), managers often seek guidance from research. Yet, researchers have also been bombarded - not just with new practices, but also with new theories. Included in this theoretic barrage is agency theory, tournament models, contingency theory, institutional theory, procedural justice, political influence theory, organizational demography, resource dependency, psychological contracts, and the resource-based view of the firm. The list seems almost endless. If Lord Keynes is correct that theories drive practical peoples\u27 decisions, understanding which of these theories is useful and which is not is important for both compensation researchers and practical decision makers

Managerial Power and Rent Extraction in the Design of Executive Compensation

This paper develops an account of the role and significance of managerial power and rent extraction in executive compensation. Under the optimal contracting approach to executive compensation, which has dominated academic re-search on the subject, pay arrangements are set by a board of directors that aims to maximize shareholder value. In contrast, the managerial power approach suggests that boards do not operate at arm's length in devising executive compensation arrangements; rather, executives have power to influence their own pay, and they use that power to extract rents. Furthermore, the desire to camouflage rent extraction might lead to the use of inefficient pay arrangements that provide suboptimal incentives and thereby hurt shareholder value. The authors show that the processes that produce compensation arrangements, and the various market forces and constraints that act on these processes, leave managers with considerable power to shape their own pay arrangements. Examining the large body of empirical work on executive compensation, the authors show that managerial power and the desire to camouflage rents can explain significant features of the executive compensation landscape, including ones that have long been viewed as puzzling or problematic from the optimal contracting perspective. The authors conclude that the role managerial power plays in the design of executive compensation is significant and should be taken into account in any examination of executive pay arrangements or of corporate governance generally.

Does Globalization Create Superstars?

To examine the impact of globalization on managerial compensation, we consider a matching model where a number of firms compete both in the product market and in the managerial market. We show that globalization, i.e. the simultaneous integration of product markets and managerial pools, leads to an increase in the heterogeneity of managerial salaries. Typically, while the most able managers obtain a wage increase, less able managers are faced with a reduction in wages. Hence our model can explain the increasing heterogeneity of CEO compensation that has been observed in the last few decades.Globalization, manager remuneration, superstars

Us Knows Us in the UK: On Director Networks and CEO Compensation

We analyze the relation between CEO compensation and networks of executive and non-executive directors for all listed UK companies over the period 1996-2007. We examine whether networks are built for reasons of information gathering or for the accumulation of managerial influence. Both indirect networks (enabling directors to collect information) and direct networks (leading to more managerial influence) enable the CEO to obtain higher compensation. Direct networks can harm the efficiency of the remuneration contracting in the sense that the performance sensitivity of compensation is then lower. We find that in companies with strong networks and hence busy boards the directors’ monitoring effectiveness is reduced which leads to higher and less performance-sensitive CEO compensation. Our results suggest that it is important to have the ‘right’ type of network: some networks enable a firm to access valuable information whereas others can lead to strong managerial influence that may come at the detriment of the firm and its shareholders. We confirm that there are marked conflicts of interest when a CEO increases his influence by being a member of board committees (such as the remuneration committee) as we observe that his or her compensation is then significantly higher. We also find that hiring remuneration consultants with sizeable client networks also leads to higher CEO compensation especially for larger firms.Executive remuneration;Professional and social networks;Corporate governance;Managerial Power;Remuneration consultants

MANAGERIAL POWER, STOCK-BASED COMPENSATION, AND FIRM PERFORMANCE: THEORY AND EVIDENCE

This paper studies theoretically and empirically the relation among CEO power, CEO compensation and firm performance. Our theoretical model follows the rent extraction view of CEO compensation put forward by the managerial power theory, and proxies CEO power by the bargaining power the CEO exercises in the determination of his compensation contract. We show (i) when there is no constraint on the CEO's salary, the CEO's stock-based compensation and the pay-performance sensitivity of CEO compensation are both independent of CEO power, although firm performance net of CEO compensation worsens as CEO power increases, and (ii) when the CEO's salary has a binding cap, the CEO's stock-based compensation and the pay-performance sensitivity of CEO compensation are both increasing in CEO power, resulting in better firm performance gross of CEO compensation, but worse firm performance net of CEO compensation. We test our theoretical findings using the sample of S&P1500 firms over the period of 2001-2005. The predicted relation between power and pay is largely supported. However, the relation between power and firm performance as predicted by theory has mixed support. This suggests that, while the managerial power theory has clear relevance in explaining the relation between power and pay, the scope of power needs to be broadened to have better understanding of how managerial power affects firm performance.Managerial power, agency theory, stock-based incentives, firm performance, pay-performance sensitivity.

Executive compensation and the susceptibility of firms to hostile takeovers : An empirical investigation of the U.S. oil industry

We investigate the suggested substitutive relation between executive compensation and the disciplinary threat of takeover imposed by the market for corporate control. We complement other empirical studies on managerial compensation and corporate control mechanisms in three distinct ways. First, we concentrate on firms in the oil industry for which agency problems were especially severe in the 1980s. Due to the extensive generation of excess cash flow, product and factor market discipline was ineffective. Second, we obtain a unique data set drawn directly from proxy statements which accounts not only for salary and bonus but for the value of all stock-market based compensation held in the portfolio of a CEO. Our data set consists of 51 firms in the U.S. oil industry from 1977 to 1994. Third, we employ ex ante measures of the threat of takeover at the individual firm level which are superior to ex post measures like actual takeover occurrence or past incidence of takeovers in an industry. Results show that annual compensation and, to a much higher degree, stock-based managerial compensation increase after a firm becomes protected from a hostile takeover. However, clear-cut evidence that CEOs of protected firms receive higher compensation than those of firms considered susceptible to a takeover cannot be found

CEO Power and Compensation in Financially Distressed Firms

We study the changes in CEO power and compensation that arise when firms go through financial distress. We use a matching estimator to identify suitable controls and estimate the causal effects of financial distress for a sample of U.S. public companies from 1992 to 2005. We document that, relative to those in control firms, the CEOs of distressed firms experience significant reductions in total compensation; the bulk of this reduction derives from the decline in value of new grants of stock options. These results hold not only for incumbent CEOs but also, surprisingly, for newly hired CEOs. Financial distress has important consequences on corporate governance, decreasing managerial influence over the board. We find that, among distressed firms, there is a significant decrease in the proportion of CEOs holding board chairmanship, and in the fractions of executives serving as directors or in the compensation committee of the board. We also show that periods of financial distress are associated with a decrease in opportunistic timing behavior of stock option awards. The results are suggestive of a link between managerial power and executive compensation.CEO compensation, financial distress, lucky grants, managerial influence, bias-corrected matching estimators

Managerial Compensation in Midwestern Cooperatives: Results from a Follow-up Study

Results are presented from a follow-up survey of managerial compensation practices in local farm supply and marketing cooperatives in Minnesota, North Dakota, and Wisconsin. In contrast to findings from the original survey, total compensation levels, bonuses, and changes in compensation are all found to be positively and significantly associated with local net margin and not closely related to sales and sales growth.Agribusiness,

Not So Lucky Any More: CEO Compensation in Financially Distressed Firms

There is a debate on whether executive pay reflects rent extraction due to "managerial power" or is the result of arms-length bargaining in a principal-agent framework. In this paper we offer a test of the managerial power hypothesis by empirically examining the CEO compensation of U.S. public companies that were ever in financial distress between 1992 and 2005. Using a bias-corrected matching estimator that estimates the causal effects of financial distress, we find that, for the distressed firms, CEO turnover rates increase markedly and their CEOs, both incumbents and successors, experience significant reductions in total compensation. The bulk of the reduction in total compensation derives from the decline in value of stock option grants, which we argue is due to a change in the opportunistic timing of option grants. We define "lucky" grants as those with grant prices below or at the lowest stock price of the grant month, and we find that the proportion of lucky grants for financially distressed firms is higher before insolvency and lower upon and after insolvency, while the proportion for similar but solvent firms remains stable throughout the period. We interpret this evidence as consistent with a decrease in managerial power induced by a tightening in the "outrage" constraint due to the episode of financial distress.CEO compensation, CEO turnover, financial distress, lucky grants, bias-corrected matching estimators

Employment Stability Under Different Managerial Compensation Systems

Compensation design may influence the extent to which managerial decision-makers take a long-term perspective in managing important resources like employees. I hypothesize that organizations relying more heavily on long-term compensation incentives exhibit greater stability in employment, perhaps because of a greater concern among management with long-term effectiveness. I also hypothesize that employment stability is more feasible when employees are covered by variable pay plans, which permit labor cost reductions without cuts in employment. Using multiple years of employment, financial performance, and managerial compensation data on 156 organizations, support is found for both hypotheses