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Project

With a little help from my friends: How CEO-compensation committee ties affect the pay setting process.

The aim of this dissertation is to provide insight into how the composition of the compensation committee affects the design of executive compensation contracts.

The fact that companies award generous compensation packages to executives when financial results are under pressure raises many questions in the eyes of legislators, stock exchange commissions and the public at large. Over the course of the past forty years, U.S. CEO compensation has risen by more than 800 percent, a rise that is more than double the stock market growth of the concerning firms. Also, this increase is substantially greater than the modest 11.2 percent growth in average worker annual compensation over the same period (Mishel and Schieder 2018), resulting in rising income inequality (Kim, Kogut and Yang 2015; Piketty 2014). Furthermore, public outrage about executive compensation packages has increased substantially since the global financial crisis. In response to such concerns, several legislative efforts to reform executive compensation have been undertaken in the U.S. as well as in Europe. The Dodd-Frank act requires listed companies, through new rules adopted by the stock exchanges, to have a compensation committee composed entirely of independent directors. As a result, U.S. stock exchanges are now prohibited from listing public companies that do not have an independent compensation committee. Largely overlooked by regulators and researchers has been the composition of compensation committees beyond independence. The focus of this dissertation is therefore to examine the composition of the compensation committee in depth. In particular, I examine how connections within and between firms as well as different types of expertise affect the functioning and decision-making of compensation committees. The goal of this dissertation is to increase our understanding of how such within- and between compensation committee dynamics affect the design of effective CEO pay packages, beyond independence.

In the first chapter, we investigate whether compensation committee expert directors enhance the effectiveness of compensation committee monitoring over the pay setting process. We thereby focus on the selection of peer firms, as in many firms executive compensation is tied directly to pay at a group of peer companies. Overall, our results suggest that CEOs can exert substantial influence on the process of compensation benchmarking, either through appointing friendly directors to the compensation committee or through occupancy of an influential or key position on the board. Furthermore, we show that the presence of at least one industry expert member in the compensation committee effectively mitigates the effect of opportunistic peer selection

Chapter two offers empirical evidence of imitation in the design of incentive contracts, as firms are likely to copy CSR incentive contracts of their tied-to partners. Importantly, the results indicate that imitation not only occurs through compensation committee interlocks, but also via CEO interlocks. In the second part of this study, we examine several consequences of compensation imitation. The results indicate that imitation does not always result in suboptimal contracts. Specifically, we show that if compensation committee members imitate CSR performance measures from tied-firms, imitation is likely to be efficient as it is associated with increased firm financial and nonfinancial performance. On the other hand, if imitation occurs through CEO interlocks, our results indicate that the incentives might be distorted.

Finally, in the third chapter, we show that self-serving incentives explain high compensation levels in firms with CEO directors on the compensation committee. We argue that the peer group benchmarking mechanism used in many firms to determine executive pay may create selfserving incentives for CEO directors to inflate pay levels. The results in this chapter show that the shorter the distance in terms of peer group connections from the CEO director’s home firm to the firm where she sits on the compensation committee, the higher CEO compensation in the latter firm.

Date:3 Oct 2016 →  31 Dec 2021
Keywords:Executive compensation
Disciplines:Applied economics
Project type:PhD project