Factors Influencing CEO Compensation in US Industry
Ball State university
CEO compensation has always been part of industry discussion. Executive compensation is complex and daunting subject. The debate over CEO compensation raises questions such as Are CEO overpaid? Who is highest paid CEO? Is CEO pay and average worker pay proportional related? 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 of factors affecting CEO pay and the relationship between pay and firm performance.
In united states compensation of executive has raise dramatically over the past three decades. It highest in the world both in absolute terms and relative median salary in the US. CEO compensation as peaked in 2000 and again surged in 2017. Few issue has attracted a lot of attention to executive compensation particularly dealing with agency problem. CEO pay is really tied with company performance. According to study Over the short term they may be well-aligned, but over the long term it’s so evenly distributed that it’s almost a random sampling. The report shows a scattershot relationship between total shareholder return and executive pay over 10 years period. Further it has been a point of discussion on why so much divergence between CEO pay and work pay. Despite of economic turmoil, CEO compensation in US has apparently continued to rise regardless of both economic condition and company’s performance, wages of average worker has remained comparatively flat.
The objective of this paper is to identify set of factors which influence CEO compensation. This research will shed light on relationship of firm performance and executive compensation and help us to understand whether CEO compensation has outpaced corporate profit and economic growth. Many studies have tried to answer this question, but results were not clear. Johnson (1982), Finkelstein and Boyd (1998), Tosi et al. (2000) found no relationship between these two variables whereas Belliveau et al. (1996), Brick et al. (2005) and Ozkan (2007) found a strong and positive relationship between them. Following the previous studies, this paper tries to determine whether there is relationship between executive pay across eight US industries and performance of those firm.
There are lot of research paper, that will be examined further, that analysed particular industries and countries from view point of CEO compensation. In this paper we decided to do analysis of largest industries across US as previous research did not analysed this industries and this brings novelty to paper. We will outline the main drivers that influence the CEO compensation. On the basis of the obtained result, in the conclusion section we will develop a set of recommendation for studied industries that assist to determine pay-performance relationship across eight industries.
Since the 1990’s attention has increased regarding the discussion about this subject for two main reasons. First, several highly publicised cases of excessive compensation contracts for executives have been linked to large scandals in the United States (e.g.: Enron) and in the United Kingdom (e.g.: Prudential and Vodafone). Another example in Belgium is the golden parachute of Pierre Mariani in 2012 after failing to save Dexia (Vanbrussel, 2013). Second, the global financial crisis of 2008 sharpened the focus even more on the issue of CEO compensation practices in the financial sector and more emphasis is given on pay-performance post 2008 crisis.
Nowadays lot of attention is given to executive compensation as an effective mechanism of corporate governance and in particular of agency problem. Properly awarded executive in most cases does not have an incentive to operate in self-interest and act irresponsibly, but maximization of the company’s value.
In this section, we present a brief review of existing studies that have examined the relationship between executive compensation and firm performance. We further emphasise the potential contribution from the present study.
Executive compensation and firm performance
One of the earliest study by Jensen murphy (1990) examined the relationship between firm performance and executive pay. They considered a large US company from 1974-1986 and they estimated pay for performance sensitivity and reported positive relationship between CEO compensation and firm performance.
According to Hall and Liebman (1998) there is strong positive correlation between firm performance and CEO pay. They have examined 15 years panel data of US companies. This relationship is generated entirely by change is the value of CEO holding of stock and stock options.
Boschen and Smith (1995) study represent relationship between executive compensation and a firm’s past as well as contemporaneous performance. They concluded that past performance has a significant influence on current compensation, but the effect is not permanent. Their study also reports changes in pay–performance sensitivity over the four decades of their study period.
Executive compensation and firm specific characteristics
Firm specific characteristic such as firm size, capital structure expected to affect executive compensation. Rosen (1992) determine how CEO pay positively related to firm size. Murphy (1999), on the contrary, reported that pay–performance sensitivity is weaker among the larger US firms. In the light of this mixed evidence on the relationship between executive compensation and firm size, we empirically examine the relationship among our sample firms. Further, we classify our sample firms into small as well as large sub-samples and investigate the pay–performance sensitivity separately.
Firm specific is another potential determinant of executive compensation. We consider beta as a measure of risk for the firm with respect to market. Studies such penman (2007) support the argument that there is negative relation between firm leverage and executive pay.
In light of above inconclusive evidence on pay-performance this study examines the set of factors that influence the executive compensation of US industry.
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