Institute for Compensation Studies

Classic Promotion Tournaments Versus Market-Based Tournaments

Michael Waldman — Fri, 04 Nov 2011 12:39:03 PDT

As initially formulated in the seminal analysis of Lazear and Rosen (1981), an important perspective for understanding the role of promotions in firms is the tournament perspective. That is, a promotion and, in particular, the wage increase associated with a promotion is a prize that serves as an incentive for workers to exert effort and take other actions beneficial to the firm such as the accumulation of human capital. In this paper I consider whether the best way to model promotion tournaments is by having firms commit to prizes ex ante as in Lazear and Rosen’s initial formulation, or whether promotion prizes should be modeled as arising from the signaling role of promotions and the competition between firms for promoted workers.

Executive Compensation in American Unions

Kevin Hallock et al. — Thu, 23 Jun 2011 10:59:38 PDT

[Exerpt] 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 which allows us to examine within union differences over time. 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. That is, within the same union, higher levels of membership size and average member wage over time are associated with higher levels of pay for union leaders. 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.

Job Loss and Effects on Firms and Workers

Kevin F. Hallock et al. — Fri, 10 Jun 2011 07:06:28 PDT

This paper serves as an introduction and (incomplete) survey of the wide-ranging literature on job loss. We begin with a discussion of job stability in the US and the commitment between firms and workers, and how this has changed in recent years. We then focus on the short and long-term consequences to workers (i.e. wages, health outcomes) following a layoff, and the effect which mass layoffs have on future firm performance. The changing nature of these relationships over the past several decades is a central theme of this paper. We review the common data sources used to examine these questions, and identify many influential papers on each topic. Additionally, we discuss alternative policies to the typical mass layoff, such as worksharing.

Keeping Up with CEO Jones: Benchmarking and Executive Compensation

Ron Laschever — Thu, 31 Mar 2011 10:51:49 PDT

This paper seeks to understand the role that peer comparisons play in the determination of executive compensation. I exploit a recent change in the Securities and Exchange Commission’s regulations that requires firms to disclose the peer companies used for determining the compensation of their top executives. Using a new dataset of S&P 900 companies’ choice of benchmarking firms during two fiscal periods (2007 and 2008), I investigate what determines the choice of comparison firms. I find that companies have a preference for choosing larger and higher-CEO-compensation firms as their benchmark. Though I find that companies prefer to choose as their benchmark peers with similar firm characteristics, for CEO compensation, this effect is countered by a preference for firms with higher-than-own CEO compensation. Using the complete map of firms’ choices, I implement an instrumental variable strategy that uses the characteristics of peers-of-peers to estimate the effect of others’ compensation on own compensation. For Fiscal Year 2007, I find an elasticity of 0.5.

Executive Compensation and Corporate Governance in China

Martin J. Conyon et al. — Mon, 28 Feb 2011 09:57:48 PST

We investigate executive compensation and corporate governance in China’s publicly traded firms. We also compare executive pay in China to the USA. Consistent with agency theory, we find that executive compensation is positively correlated to firm performance. The study shows that executive pay and CEO incentives are lower in State controlled firms and firms with concentrated ownership structures. Boardroom governance is important. We find that firms with more independent directors on the board have a higher pay-for-performance link. Non-State (private) controlled firms and firms with more independent directors on the board are more likely to replace the CEO for poor performance. Finally, we document that US executive pay (salary and bonus) is about seventeen times higher than in China. Significant differences in US-China pay persist even after controlling for economic and governance factors.

The Executive Compensation Controversy: A Transatlantic Analysis

Martin J. Conyon et al. — Mon, 28 Feb 2011 09:45:01 PST

The recent financial crisis has created a public uproar over top-executive pay packages and has led to calls for reform of executive pay in Europe and the United States. The current controversy is not the first – nor will it be the last – time that executive compensation has sparked outrage and led to regulation on both sides of the Atlantic. In this report, we trace the evolution of executive compensation, its controversies and its resulting regulations, which have typically come in the form of tax policies, disclosure rules, and accounting standards. We show that many features of current executive compensation practices reflect the oftenunintended consequences of regulatory responses to perceived abuses in top-executive pay, often stemming from relatively isolated events or situations.

Based on a comprehensive comparison of pay spanning six years and covering approximately 1,500 US firms and 900 firms from nine European countries, we show that US CEOs are paid only modestly more than their European counterparts after controlling for firm, ownership, and board characteristics. Moreover, we find that pay is more tightly linked to performance in the United States than throughout most of Europe, and that American executives hold more wealth in company stock and options than do their European counterparts. Indeed, we conclude that most of the difference in cross-continental pay levels is attributable to the higher use of stock and options in the United States, which in turn is related to a variety of tax, accounting, and social policies that have encouraged option grants in the United States.

The “bright spot” for incentives for European CEOs occurs in an unlikely place: the banking sector. We document a statistically strong relation between bonuses and shareholder returns for European banks, and an insignificant relation in non-banks. We also find that banking executives on both sides of the Atlantic suffered large personal losses during the recent crisis compared to their non-banking counterparts. Our evidence is inconsistent with claims that excessive risk taking in that sector was caused by the “banking bonus culture.”

While pay design can always be improved and there will always be isolated abuses, we urge governments to resist temptations to further regulate pay in both banking and nonbanking sectors. Part of the problem is that regulation – even when well intended – always creates unintended (and usually costly) side effects. Moreover, regulation is often designed to be punitive rather than constructive, and is inherently driven by politicians more interested in their political agendas rather than creating shareholder value. Ultimately, we conclude that improvements in executive compensation will best emanate through stronger corporate governance, and not through direct government intervention.

Wages or Fringes? Some Evidence on Trade-offs and Sorting

Tor Eriksson et al. — Fri, 21 Jan 2011 06:55:08 PST

The two key predictions of hedonic wage theory are that there is a trade-off between wages and nonmonetary rewards and that the latter can be used as a sorting device by firms to attract and retain the kind of employees they desire. Empirical analysis of these topics are scarce as they require detailed data on all monetary as well as nonmonetary rewards, not only for the job chosen but also for alternative offers. In this paper this data predicament is solved by the use of the vignettes method to estimate individuals' willingness to pay for fringe benefits and job amenities. We find clear negative wage-fringe trade-offs, considerable heterogeneity in willingness to pay for fringe benefits, and signs of sorting. The findings imply that personnel economics models can be applied also to the analysis of nonmonetary rewards.

Agency and Compensation: Evidence from the Hotel Industry

Matthew Freedman et al. — Tue, 11 Jan 2011 07:29:31 PST

We examine the relationship between employee supervision and compensation by taking advantage of the structure of the hotel industry, in which many chains have both company managed and franchised properties. Given that supervision is less rigorous at company managed establishments, we estimate differences in wages and human resource practices not only across company managed and franchised hotels within chains, but also within individual hotels as they change organizational form. While we cannot rule out the use of efficiency wages, our results suggest that agency problems affect the timing of pay and employers’ propensity to use performance-based incentives.

Immigrant Heterogeneity and the Earnings Distribution in the United Kingdom and United States: New Evidence from a Panel Data Quantile Regression Analysis

Sherrilyn M. Billger et al. — Tue, 14 Dec 2010 14:37:58 PST

In this paper we use a relatively new panel data quantile regression technique to examine native-immigrant earnings differentials 1) throughout the conditional wage distribution, and 2) controlling for individual heterogeneity. No previous papers have simultaneously considered these factors. We focus on both women and men, using longitudinal data from the PSID and the BHPS. We show that country of origin, country of residence, and gender are all important deter- minants of the earnings differential. For instance, a large wage penalty occurs in the U.S. among female immigrants from non-English speaking countries, and the penalty is most negative among the lowest (conditional) wages. On the other hand, women in Britain experience hardly any immigrant-native wage differential. We find evidence suggesting that immigrant men in the U.S. and the U.K. earn lower wages, but the most significant results are found for British workers emigrating from non-English speaking countries. The various differentials we report in this paper reveal the value of combining quantile regression with controls for individual heterogeneity in better understanding immigrant wage effects.

Social Preferences and the Efficiency of Bilateral Exchange

Daniel J. Benjamin — Fri, 30 Jul 2010 11:36:57 PDT

Under what conditions do social preferences, such as altruism or a concern for fair outcomes, generate efficient trade? I analyze theoretically a simple bilateral exchange game: Each player sequentially takes an action that reduces his own material payoff but increases the other player’s. Each player’s preferences may depend on both his/her own material payoff and the other player’s. I identify necessary conditions and sufficient conditions on the players’ preferences for the outcome of their interaction to be Pareto efficient. The results have implications for interpreting the rotten kid theorem, gift exchange in the laboratory, and gift exchange in the field.