Wolves in the Hen-House? The Consequences of Formal CEO Involvement in the Executive Pay-Setting Process

New Zealand firms exhibit significant variation in the extent to which they formally involve CEOs in the executive pay-setting process: a considerable number sit on the compensation committee, while others are excluded from the board altogether. Using 1997-2005 data, we find that CEOs who sit on the compensation committee obtain generous annual pay rewards that have low sensitivity to poor performance shocks. By contrast, CEOs who are not board members receive pay increments that have low mean and high sensitivity to firm performance. Moreover, the greater the pay increment attributable to CEO involvement in the pay-setting process, the weaker is subsequent firm performance over one, three- and five-year periods.pay-performance sensitivity; compensation committee; CEO influence

Dynamic Willingness to Pay: An Empirical Specification and Test

In a static setting, willingness to pay for an environmental improvement is equal to compensating variation. However, in a dynamic setting characterized by uncertainty, irreversibility, and the potential for learning, willingness to pay may also contain an option value. In this paper, we incorporate the dynamic nature of the value formulation process into a study using a contingent valuation method, designed to measure the value local residents assign to a north-central Iowa lake. Our results show that willingness to pay is highly sensitive to the potential for future learning. Respondents offered the opportunity to delay their purchasing decisions until more information became available were willing to pay significantly less for improved water quality than those who faced a now-or-never decision. The results suggest that welfare analysts should take care to accurately represent the potential for future learning.Clear Lake, contingent valuation, water quality, willingness to pay.

Show Me the Money: The CEO Pay Ratio Disclosure Rule and the Quest for Effective Executive Compensation Reform

This Note discusses past attempts to combat growing levels of executive compensation, analyzes the role of both shareholders and directors in the compensation-setting process, and discusses conflicting views concerning shareholder-director power, the disclosure mechanism, and the pay-ratio metric. Finally, this Note balances these views by proposing alterations to the CEO Pay Ratio Disclosure Rule that preserve the long-standing corporate structure, while also offering shareholders an accountability mechanism to enhance the Rule’s intended results

Board committees, CEO compensation, and earnings management

We analyze the effect of committee formation on how corporate boards perform two main functions: setting CEO pay and overseeing the financial reporting process. The use of performance-based pay schemes induces the CEO to manipulate earnings, which leads to an increased need for board oversight. If the whole board is responsible for both functions, it is inclined to provide the CEO with a compensation scheme that is relatively insensitive to performance in order to reduce the burden of subsequent monitoring. When the functions are separated through the formation of committees, the compensation committee is willing to choose a higher pay-performance sensitivity as the increased cost of oversight is borne by the audit committee. Our model generates predictions relating the board committee structure to the pay-performance sensitivity of CEO compensation, the quality of board oversight, and the level of earnings management

Wolves in the Hen-House? The Consequences of Formal CEO Involvement in the Executive Pay-Setting Process

New Zealand firms exhibit significant variation in the extent to which they formally involve CEOs in the executive pay-setting process: a considerable number sit on the compensation committee while others are excluded from the board altogether. Using 1997-2005 data we find that CEOs who sit on the compensation committee obtain generous annual pay rewards that have low sensitivity to poor performance shocks. By contrast CEOs who are not board members receive pay increments that have low mean and high sensitivity to firm performance. Moreover the greater the pay increment attributable to CEO involvement in the pay-setting process the weaker is subsequent firm performance over one three- and five-year periods

CEO Compensation

This paper surveys the recent literature on CEO compensation. The rapid rise in CEO pay over the past 30 years has sparked an intense debate about the nature of the pay-setting process. Many view the high level of CEO compensation as the result of powerful managers setting their own pay. Others interpret high pay as the result of optimal contracting in a competitive market for managerial talent. We describe and discuss the empirical evidence on the evolution of CEO pay and on the relationship between pay and firm performance since the 1930s. Our review suggests that both managerial power and competitive market forces are important determinants of CEO pay, but that neither approach is fully consistent with the available evidence. We briefly discuss promising directions for future research

The Problem of Nonprofit Executive Pay?: Evidence from U.S. Colleges and Universities

Nonprofit organizations suffer from agency problems that are similar to or perhaps even more severe than those observed at for-profit companies. As a result, one might expect the executive pay setting process in the two sectors to reflect similar deficiencies. This Article explains why the managerial power theory that was developed to help explain for-profit executive pay is plausibly applicable to nonprofits. More importantly, this Article offers new evidence based on data from a large panel of colleges and universities collected across a nine year period that supports the idea that potential stakeholder outrage plays a role in limiting nonprofit executive pay. For example, we find for the first time evidence of an otherwise counter-intuitive negative association between the fraction of university revenue provided by current donations and president compensation. We also are the first to find that excess executive pay reduces donations. These findings support the hypothesis that donors with less leverage suffer from significant agency costs in setting president pay. We discuss the implications of these findings for the regulation of nonprofits and for a broader understanding of the pay-setting process at for-profit as well as nonprofit organizations. For example, we note that our results are consistent with the view that, absent reforms, presidents may have self-interested incentives to increase tuition

Minimum wages and their role in the process and incentives to bargain

The study is based on four sources of data: (a) a survey of over 11,500 non-public sector organisations, (b) quantitative analysis of over 25,000 enterprise agreements, (c) qualitative analysis of 91 strategically selected agreements; and (d) 20 workplace case studies. Key findings (indicative) Organisations commonly used a number of pay-setting arrangements for their employees, with individual arrangements (at 65 per cent of organisations) and award based arrangements (52 per cent) the most common. The quantitative analysis of enterprise agreements found that that there may be a positive association between wage increases in enterprise agreements and Annual Wage Review increases. This was particularly the case for industries with higher proportions of agreements paying low wage increases and with a large number of award-reliant employees. The qualitative analysis of agreements identified the importance of distinguishing between agreements that are ‘award-reliant’, ‘slightly above award’ (i.e. pay modest over-awards) and ‘over-award’ (i.e. pay substantial amounts more than the award).  External relativities (i.e. differences in pay for exemplar or reference classifications common across employers) were dispersed among all industries considered. Internal relativities within agreements were very similar to those in their related awards. The case studies found little direct impact of Annual Wage Review decisions on wage outcomes or pay-setting processes – they are best conceived as third order factors shaping both. Conclusion While the direct impact of Annual Wage Review decisions was perceived to be limited at the work sites studied, this is not the whole story. The analysis of agreements revealed that there may be positive significant associations between Annual Wage Review increases and agreement content. The workplace cases in general, and the relativities analysis in particular, revealed that awards profoundly shape wage outcomes and the wage determination process.  In particular, the agreement and case study findings highlighted the importance of not conceiving the different pay-setting arrangements in mutually exclusive terms. If the Annual Wage Review increases examined are conceived as being part of an ongoing evolution of the award system, then their impact is better understood as being very significant, primarily because such increases are an integral part of labour standard regime that conditions workplace behaviour and shapes wage outcomes. This appears to be especially the case in those parts of the labour market paying below median wages

Compensation Representatives: a Prudent Solution to Excessive CEO Pay

Currently, CEO pay is determined by a company’s board of directors, subject to limited shareholder approval in certain circumstances. However, as Lucian Bebchuk and Jesse Fried have demonstrated, boards of directors and CEOs do not necessarily engage in real arms length bargaining over CEO pay. Instead, CEOs may exert managerial power to extract economic rents above and beyond what they could have obtained in an arms length negotiation. To address the problem, Bebchuk and Fried have proposed that large shareholders be allowed to nominate candidates for the board, and that companies be required to pay the expenses for any proxy fight if the shareholder’s nominee receives a designated minimum level of support. Some commentators have taken issue with their conclusion that CEOs are in fact overpaid, and others have objected to their proposed remedies. This article accepts the fundamental point that the CEO pay-setting process is flawed and that reforms are necessary. Nonetheless, it recognises that high CEO pay may be attributable to numerous factors other than managerial power, and it questions whether certain of Bebchuk and Fried’s proposed solutions might have unintended negative consequences for matters beyond CEO pay. Therefore, to remedy the problems in the pay-setting process, this article proposes that large shareholders be allowed to appoint non-executive “compensation representatives” to look after the interests of all shareholders on matters relating exclusively to CEO pay. Compensation representatives would have the right to attend all compensation-related meetings, to question board members, to make recommendations, and to report their views to shareholders. Shareholders in turn could use the representative’s report as a basis for rejecting unreasonable pay arrangements. This proposal would insert into the pay-setting process parties who are immune to CEO pressure and responsive to shareholder concerns. It would address compensation without fundamentally altering the relationship between the shareholders and the board. Its implementation is highly feasible, since it could be adopted by shareholder by-law, without changing existing law. Finally, it could be vindicated or discredited by the market itself. As such, it would constitute a prudent solution to excessive CEO pay

Stock Options for Undiversified Executives

We employ a certainty-equivalence framework to analyze the cost and value of, and pay/performance incentives provided by, non-tradable options held by undiversified, risk-averse executives. We derive Executive Value' lines, the risk-adjusted analogues to Black-Scholes lines, and distinguish between executive value' and company cost.' We demonstrate that the divergence between the value and cost of options explains, or provides insight into, virtually every major issue regarding stock option practice including: executive views about Black-Scholes measures of options; tradeoffs between options, stock and cash; exercise price policies; connections between the pay-setting process and exercise price policies; institutional investor views regarding options and restricted stock; option repricings; early exercise policies and decisions; and the length of vesting periods. It also leads to reinterpretations of both cross-sectional facts and longitudinal trends in the level of executive compensation.