Compensation Research Initiative

Performance Pay and the White-Black Wage Gap

John S. Heywood et al. — Fri, 02 Apr 2010 06:21:03 PDT

We show that the reported tendency for performance pay to be associated with greater wage inequality at the top of the earnings distribution applies only to white workers. This results in the white-black wage differential among those in performance pay jobs growing over the earnings distribution even as the same differential shrinks over the distribution for those not in performance pay jobs. We show this remains true even when examining suitable counterfactuals that hold observables constant between whites and blacks. We explore reasons behind our finding that performance pay is associated with greater racial earnings gaps at the top of the wage distribution focusing on the interactions between discrimination, unmeasured ability and selection.

Board Independence and the Gender Pay Gap for Top Executives

Karen Selody — Wed, 10 Mar 2010 08:29:42 PST

Since the early 1990s, a 25%-45% gender pay gap has persisted for the top five executives in U.S. publicly traded companies. I present an empirical approach to determine the relative importance of two possible explanations for the gender pay gap that originate with employers: gender taste-based discrimination, and downward-biased beliefs about women's performance. I use the 2003 SEC regulation event that required boards to become more independent and disallowed insiders to serve on the compensation committee to distinguish between the two possible causes of discrimination. Independent board members do not work alongside executives and so would be less inclined than insiders to indulge in taste-based discrimination. Independent board members, on the other hand, have less information about executives' performance and are thus more likely to rely on their prior, potentially biased beliefs about women's performance when they set pay. I find that the gender pay gap became 19% larger in firms that were required to convert to more independent boards compared to firms that were not, which is not consistent with taste-based discrimination. An increase in the pay gap is consistent with downward-biased beliefs about women's performance, but also with reverse taste-based discrimination. I distinguish between these two hypotheses by examining whether the increase in the pay gap is persistent and uniform across positions. I find the increase in the pay gap reverted as independent board members had time to learn about individual performance. And, the gap did not widen in occupations where accreditation provided an easy-to-interpret signal of ability. These results are consistent with board members having downward-biased beliefs about women's performance.

Executive Pay and Firm Performance: Methodological Considerations and Future Directions

Beth Florin et al. — Wed, 10 Mar 2010 08:23:25 PST

This paper is an investigation of the pay-for-performance link in executive compensation. In particular we document main issues in the pay-performance debate and explain practical issues in setting pay as well as data issues including how pay is disclosed and how that has changed over time. We also provide a summary of the state of CEO pay levels and pay mix in 2009 using a sample of over 2,000 companies and describe main data sources for researchers. We also investigate what we believe to be at the root of fundamental confusion in the literature across disciplines – methodological issues. In exploring methodological issues, we focus on empirical specifications, causality, fixed-effects, first- differencing and instrumental variables issues. We then discuss two important but not yet well explored areas; international issues and compensation in nonprofits. We conclude by examining a series of research areas where further work can be done, within and across disciplines.

Negative Hedging: Performance Sensitive Debt and CEOs’ Equity Incentives (CRI 2009-014)

Alexei Tchistyi et al. — Tue, 20 Oct 2009 11:27:32 PDT

We examine the relation between CEOs’ equity incentives and their use of performance-sensitive debt contracts. These contracts require higher or lower interest payments when the borrower's performance deteriorates or improves, thereby increasing expected costs of financial distress while making a firm riskier to the benefit of option holders. We find that managers whose compensation is more sensitive to stock volatility choose steeper and more convex performance pricing schedules, while those with high delta incentives choose flatter, less convex pricing schedules. Performance pricing contracts therefore seem to provide a channel for managers to increase firms’ financial risk to gain private benefits.

Theory and Evidence in Internal Labor Markets (CRI 2009-013)

Michael Waldman — Tue, 20 Oct 2009 11:27:31 PDT

A number of branches of the literature on internal labor markets have matured to the point that there is now a healthy two-way interaction between theory and empirical work. In this survey I consider two of these branches: i) wage and promotion dynamics; and ii) human-resource practices. For each case I describe the empirical and theoretical literatures and also discuss what we can learn by paying careful attention to how theoretical and empirical findings are related. In addition to surveying the literatures on these two topics, my goal is to show how a deeper understanding of internal-labor-market phenomena can be derived from a close partnering of empirical and theoretical research.

Is a Higher Calling Enough? Incentive Compensation in the Church (CRI 2009-011)

Jay C. Hartzell et al. — Tue, 20 Oct 2009 11:27:30 PDT

We study the compensation and productivity of more than 2,000 Methodist ministers in a 43-year panel data set. The church appears to use pay-for-performance incentives for its clergy, as their compensation follows a sharing rule by which pastors receive approximately 3% of the incremental revenue from membership increases. Ministers receive the strongest rewards for attracting new parishioners who switch from other congregations within their denomination. Monetary incentives are weaker in settings where ministers have less control over their measured performance.

CEO Turnover and Firm Performance in China’s Listed Firms (CRI 2009-012)

Martin Conyon et al. — Tue, 20 Oct 2009 11:27:30 PDT

Manuscript Type: Empirical

Research Question/Issue: This study investigates the relation between CEO turnover and firm performance in China’s listed firms. The study examines how the sensitivity of CEO turnover to firm performance is moderated by the private control of firms, the presence of a majority shareholder and the presence of independent directors on the board.

Research Findings/Insights: Using a panel of about 1200 Chinese firms per year from 1999 to 2006 we find significant changes in the ownership and control of firms. The private control of firms and the fraction of independent directors on the board have increased considerably over time. The study finds a significant negative association between CEO turnover and firm performance consistent with the agency model. There is evidence that the CEO turnover sensitivity for poor performance is greater in firms that are privately controlled, or have a majority shareholder, or have a greater fraction of independent directors on the board.

Theoretical/Academic Implications: This study provides empirical support for the agency model and the importance of internal corporate governance to attenuate agency costs. It provides important insights into firm governance in transition economies.

Practitioner/Policy Implications: This study offers insights to policy makers interested in enhancing the design of internal corporate governance within transition economies.

Executive Compensation and CEO Equity Incentives in China’s Listed Firms (CRI 2009-006)

Martin J. Conyon et al. — Tue, 20 Oct 2009 11:15:01 PDT

This study investigates the economic, ownership and governance determinants of executive compensation and CEO equity incentives in China’s listed firms. Consistent with the agency theory, we find that executive compensation is positively correlated with firm size, performance, and growth opportunities. CEO incentives are negatively associated with firm size, positively linked with firm performance and growth opportunity. Firm risk has a negative effect on pay and incentives. Compensation and CEO incentives are significantly greater in privately-controlled firms compared to state-run firms and are lower in firms with concentrated ownership structures. Boardroom governance is important: firms with compensation committees or a greater fraction of independent directors on the board have higher executive pay and greater CEO equity incentives.

Executive Compensation in American Unions (CRI 2009-007)

Kevin F. Hallock et al. — Tue, 20 Oct 2009 11:15:00 PDT

Studying compensation in the nonprofit sector is difficult. In nonprofit organizations, it is not always clear what the objectives of the organization are and, therefore, perhaps even more difficult to consider how to compensate managers than in the for-profit sector. This paper investigates the determinants of executive compensation of leaders of American labor unions. We use panel data on more than 75,000 organization-years of unions from 2000 to 2007. We specifically concentrate on two issues of importance to unions – the level of membership and the wages of union members. Both measures are strongly related to the compensation of the leaders of American labor unions, even after controlling for organization size and individual organization fixed-effects. Additionally, the elasticity of pay with respect to membership for unions is very similar to the elasticity of pay with respect to employees in for profit firms over the same period.

The Signaling Role of Promotions: Further Theory and Empirical Evidence (CRI 2009-008)

Jed DeVaro et al. — Tue, 20 Oct 2009 11:15:00 PDT

An extensive theoretical literature investigates the role of promotions as a signal of worker ability. In this paper we extend the theory by focusing on how the signaling role of promotion varies with a worker’s education level, and then investigate the resulting predictions using a longitudinal data set that contains detailed information concerning the internal-labor-market history of a medium-sized firm in the financial-services industry. Our results support signaling being both a statistically significant and economically significant factor in promotion decisions. The paper also contributes to the extensive literature on the role of education as a labor-market signal.

The Relative Effects of Merit Pay, Bonuses, and Long-Term Incentives on Future Job Performance (CRI 2009-009)

Sanghee Park et al. — Tue, 20 Oct 2009 11:14:59 PDT

Extant compensation literature has indicated that pay-for-performance can influence employee performance. There is little research, however, that differentiates the effects of certain forms of pay-for-performance plans on future performance. By applying the precepts of expectancy theory to specific components of the pay-for-performance plans and using longitudinal data from a sample of 739 US employees in a service-related organization, this study demonstrates different effects for merit pay, bonuses, and long-term incentives.

Compensation Consultants and Executive Pay (CRI 2009-010)

Martin J. Conyon — Tue, 20 Oct 2009 11:14:29 PDT

This chapter provides a review of the recent literature on compensation consultants and executive pay. Six major pay consulting firms dominate the market. These firms advise client firms about executive pay and frequently supply other services such as actuarial work. There is some evidence that CEO pay is higher in firms that use compensation consultants. However, the hypothesis that CEO pay is higher in firms whose consultants face potential conflicts of interest, such as cross-selling of other services, is not as empirically robust.

Standard Promotion Practices versus Up-or-Out Contracts (CRI 2009-001)

Suman Ghosh et al. — Tue, 20 Oct 2009 10:56:42 PDT

In most firms a worker in any period is either promoted, left in the same job, or fired (demotions are typically rare), and there is no specific date by which a promotion needs to occur. In other employment situations, however, up-or-out contracts are common, i.e., if a worker is not promoted by a certain date the worker must leave the firm. This paper develops a theory that explains why and when each of these practices is employed. Our theory is based on asymmetric learning in labor markets and incentives associated with the prospect of future promotion. Our main result is that firms employ up-or-out contracts when firm-specific human capital is low while they employ standard promotion practices when it is high. We also find that, if firms can commit to a wage floor for promoted workers and effort provision is important, then up-or-out contracts are employed when low-level and high-level jobs are similar. We believe these results are of interest because they are consistent with many of the settings in which up-or-out is typically observed such as law firms and academic institutions.

Are U.S. CEOs Paid More than U.K. CEOs? Inferences from Risk- Adjusted Pay (CRI 2009-003)

Martin J. Conyon et al. — Tue, 20 Oct 2009 10:56:41 PDT

We compute and compare risk-adjusted pay for US and UK CEOs, where the adjustment is based on estimated risk premiums stemming from the equity incentives borne by CEOs. Controlling for firm and industry characteristics, we find that US CEOs have higher pay, but also bear much higher stock and option incentives than UK CEOs. Using reasonable estimates of risk premiums, we find that risk-adjusted US CEO pay does not appear large compared to that of UK CEOs. We also examine differences in pay and equity incentives between a sample of non-UK European CEOs and a matched sample of US CEOs, and find that risk-adjusting pay may explain about half of the apparent higher pay for US CEOs.

CEO Pay-for-Performance Heterogeneity Using Quantile Regression (CRI 2009-002)

Kevin F. Hallock et al. — Tue, 20 Oct 2009 10:56:41 PDT

We provide some examples of how quantile regression can be used to investigate heterogeneity in pay–firm size and pay-performance relationships for U.S. CEOs. For example, do conditionally (predicted) high-wage managers have a stronger relationship between pay and performance than conditionally low-wage managers? Our results using data over a decade show, for some standard specifications, there is considerable heterogeneity in the returns to firm performance across the conditional distribution of wages. Quantile regression adds substantially to our understanding of the pay-performance relationship. This heterogeneity is masked when using more standard empirical techniques.

Shareholder Voting and Directors’ Remuneration Report Legislation: Say on Pay in the U.K. (CRI 2009-004)

Martin J. Cavanagh et al. — Tue, 20 Oct 2009 10:56:40 PDT

This paper investigates shareholder voting in the UK. The Directors’ Remuneration Report (DRR) Regulations of 2002 gave shareholders a mandatory non-binding vote on boardroom pay. First, using data on about 50,000 resolutions over the period 2002 to 2007 we find that less than 10% of shareholders abstain or vote against the mandated Directors’ Remuneration Report (DRR) resolution. Second, investors are more likely to vote against DRR resolutions compared to non-pay resolutions. Third, shareholders are more likely to vote against general executive pay resolutions, such as stock options, long term incentive plans and bonus resolutions compared to non-pay resolutions. Forth, firms with higher CEO pay attract greater voting dissent. Fifth, there is little evidence that CEO pay is lower in firms that previously experienced high levels of shareholder dissent. In addition, there is little evidence that the equity pay-mix, representing better owner-manager alignment, is greater in such firms. Currently, we find limited evidence that, on average, ‘say on pay’ materially alters the subsequent level and design of CEO compensation.

Stockholder and Bondholder Reactions To Revelations of Large CEO Inside Debt Holdings: An Empirical Analysis (CRI 2009-005)

Chenyang Wei et al. — Tue, 20 Oct 2009 10:56:39 PDT

We conduct an event study of stockholders’ and bondholders’ reactions to companies’ initial reports of their CEOs’ inside debt positions, as required by SEC disclosure regulations that became effective early in 2007. Results show that bond prices rise, equity prices fall, and the volatility of both securities drops at the time of disclosures by firms whose CEOs have sizeable pensions or deferred compensation. The results indicate a transfer of value from equity toward debt, as well as an overall destruction of enterprise value, when a CEO’s inside debt holdings are large.