CEO Compensation: Evidence From the Field

Summary

This paper explores CEO compensation practices through surveys of investors and directors, offering insights into their perspectives on setting pay. The research challenges traditional academic models by revealing a shared emphasis on attracting and incentivizing top talent over keeping pay low. It also uncovers the importance of 'fairness' in pay, with directors and investors differing on its definition. The study suggests that external pressures, like shareholder activism, can paradoxically influence pay structures, sometimes to the detriment of shareholder value. The paper provides a nuanced view of the complexities in CEO compensation, emphasizing the role of recognition and market comparisons in determining pay levels.

Takeaways

• 📊 The research paper explores CEO pay practices through surveys of investors and directors, offering a unique perspective compared to typical academic models.
• 🧩 Academic research often relies on theoretical models or empirical analysis, but this study uses a survey approach to understand real-world practices.
• 🏆 Nobel laureates like Holmström and Hart have influenced pay models, but the study aims to identify which assumptions in these models are practical and which need refinement.
• 🤝 Both directors and investors generally agree on the importance of attracting and incentivizing CEOs, but directors prioritize retention while investors focus more on incentivization.
• 📉 The study reveals that directors and investors rank 'keeping the level of pay down' as the least important objective, contrary to public and media focus.
• 💼 Directors admitted that external pressure can lead to lower CEO pay without adverse consequences, suggesting that boards might not be setting pay optimally without such pressure.
• 💭 The concept of 'fairness' plays a significant role in CEO motivation, with pay levels being compared to peers and historical benchmarks, affecting intrinsic motivation.
• 💼 Directors and investors are willing to sacrifice shareholder value to avoid controversy, indicating the influence of public opinion and other stakeholders on pay decisions.
• 📈 Pay increases are often linked to recent CEO performance, highlighting the importance of recognition and the role of salary and bonus changes in motivating CEOs.
• 💬 There is a significant disagreement between directors and investors on the potential consequences of reducing CEO pay by one-third, reflecting different views on the sensitivity of talent to pay levels.
• 💰 The study suggests that variable pay is important not just for financial incentives but also as a measure of fairness and recognition for a CEO's performance.

Q & A

What is the main focus of the paper discussed in the transcript?

The main focus of the paper is to survey both investors and directors on their perspectives and practices regarding CEO pay setting.

How does the research methodology in this paper differ from typical academic research?

The research methodology differs by using a survey approach to gather insights directly from practitioners, rather than relying solely on theoretical models or empirical analysis.

What are the three objectives of CEO pay according to standard academic models?

The three objectives of CEO pay in standard academic models are to set pay as low as possible, ensure the CEO does not quit, and incentivize the CEO to create value.

What was the surprising finding regarding the importance of keeping the level of pay down?

The surprising finding was that both directors and investors ranked keeping the level of pay down as the least important objective, suggesting that it is a third-order concern compared to retaining the CEO and incentivizing them to create value.

Why might directors and investors have different views on the importance of attracting the right CEO versus designing a pay structure that motivates the CEO?

Directors might focus more on retention, while investors might prioritize incentivization. This could be due to differing perspectives on the labor market for CEOs, with directors possibly overestimating the scarcity of suitable candidates and investors underestimating the impact of pay on motivation.

What was the unexpected consequence of directors being forced to offer lower pay due to external pressure?

The unexpected consequence was that in 41% of cases, directors admitted there were no adverse consequences, suggesting that boards might not have been exerting sufficient downward pressure on pay without external influence.

How does the concept of 'fairness' play a role in CEO pay determination according to the survey?

Fairness is considered important as it influences the CEO's intrinsic motivation. If a CEO perceives their pay as below a reference point, such as what peers are earning, they might feel undervalued and demotivated.

Why would directors and investors sacrifice shareholder value to avoid controversy on CEO pay?

They might sacrifice shareholder value to avoid controversy because of external pressures from various stakeholders like employees, customers, and policymakers, which can influence public opinion and the company's reputation.

What is the significance of peer firm CEO pay in determining the pay of a new CEO?

Peer firm CEO pay is significant because it serves as a benchmark for what is considered fair pay. Even if there is no immediate retention or recruitment concern, being paid less than peers can lead to feelings of being undervalued.

What is the role of recognition in CEO pay increases?

Recognition plays a role in CEO pay increases as it serves as a discretionary action by the board and investors to acknowledge the CEO's performance. This is seen as a form of reward and can be more motivating than automatic increases in the value of stock and options.

What is the main disagreement between directors and investors regarding the potential consequences of reducing the next CEO's pay by one-third?

The main disagreement is that investors believe there would be no adverse consequences and might even attract CEOs who are not primarily money-motivated, while directors think it would significantly reduce the talent pool and potentially lower the quality of the CEO recruited.