compensation gaps among top executives: the role of the peer groups

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Compensation gaps among top executives: the role of the peer groups Chi-Hung Chang Min-Teh Yu Jen-Chih Kuo Graduate Institute of Finance National Chiao Tung University

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Compensation gaps among top executives: the role of the peer groups. Chi-Hung Chang Min-Teh Yu Jen-Chih Kuo Graduate Institute of Finance National Chiao Tung University. Abstract. - PowerPoint PPT Presentation

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Page 1: Compensation gaps among top executives: the role of the peer groups

Compensation gaps among top executives: the role of the peer groups

Chi-Hung Chang

Min-Teh Yu

Jen-Chih Kuo

Graduate Institute of Finance

National Chiao Tung University

Page 2: Compensation gaps among top executives: the role of the peer groups

Abstract

This paper explores if the peer groups make a difference in the explanation of the compensation gaps between top executives.

We find that the productivity theory is applied to the large firm peer and the high CEO compensation peer.

The tournament effect is applied for the small firm peer and the pay gaps between non-CEO executives.

Page 3: Compensation gaps among top executives: the role of the peer groups

Background

Determinants of CEO compensation Personal characteristics – age, educational level, tenure, … Firm characteristics – firm performance Benchmarking pay level of peer groups (Bizjak et al. (2008, JFE);

Faulkender and Yang (2010, JFE)) The relevance of benchmarking pay Representing reservation wage (Hokmstrom and Kaplan (2003, JACF)) Self-serving (Bizjak et al. (2011, JFE); Faulkender and Yang (2010, JFE)) How are peer groups determined? Industry and size – Bizjak et al. (2008, JFE) Actual disclosure – Faulkender and Yang (2010, JFE)

Page 4: Compensation gaps among top executives: the role of the peer groups

Background

Compensation of non-CEO executives Productivity – Higher level managers are more productive than lower

level ones. Tournament – Compensation difference can motivate executives’

efforts. Which one dominates? Tournament incentives (Kale et al. (2009, JF)) Productivity differential (Masulis and Zhang (2012, working)) Research question: Is the peer group responsible for the difference between the

tournament and productivity effect?

Page 5: Compensation gaps among top executives: the role of the peer groups

Why is non-CEO executives’ pay relevant?

Team work of the corporation organization The gaps between CEO and other top executives vary

materially across companies (Masulis and Zhang (2012, working)). Why?

Is the CEO really extremely talented? Does the firm want to stimulate non-CEO executives’ efforts to multiply

the benefit of team work? Contagion effect in CEO compensation across companies

(Bereskin and Cicero (2012, JFE)). Non-CEO executives’ pay in other companies would be referred when determining their rewards.

Page 6: Compensation gaps among top executives: the role of the peer groups

Theories of compensation gaps

Productivity theory Rosen (1981, 1982); Gabaix and Landier (2008) –

Multiplicative productivity models Higher level managers are more productive than lower level

ones.

Tournament theory Lazear and Rosen (1981); Green and Stokey (1983);

Rosen (1986) A mechanism to elicit executives’ efforts

Page 7: Compensation gaps among top executives: the role of the peer groups

Empirical evidence of compensation gaps

Productivity differentials Finkelstein and Hambrick (1988, SMJ); Gibbs (1995, JAE);

Prendergast (1999, JEL); Anabtawi (2005, ELJ); Masulis and Zhang (2012, working)

Tournament effect Main et al. (1993, JLE); Eriksson (1999, JLE); Bognanno

(2001, JLE)

Controversy still remains.

Page 8: Compensation gaps among top executives: the role of the peer groups

Hypotheses

H1: The compensation gap in the larger peer is more likely to reflect productivity differentials.

H2: The compensation gaps in the peer group with higher CEO pay would more likely support the productivity theory.

H3: The compensation gaps between executives below the CEO would more probably reflect the tournament theory.

Page 9: Compensation gaps among top executives: the role of the peer groups

Empirical strategy

Data: Compensation data from Execcucomp over 1993-2005; firm characteristics data from Compustat.

Determining peers based on industry and size (following Bizjak et al., 2008, JFE).

Industry: 2-digit SIC code Size: median sales Size peer groups CEO compensation peers Executives compensation peers

Page 10: Compensation gaps among top executives: the role of the peer groups

Variables

CEO compensation gap Total gap = log(total CEO compensation/median total compensation of non-

CEO executives) Short-term and long-term gap are defined similarly. Non-CEO executives compensation gap Total gap = log(Highest non-CEO total compensation/lowest non-CEO

executives’ total compensation) Short-term and long-term gap are defined similarly. Tournament measure: number of non-CEO executives

Productivity measure: executive’s position tenure, the average pay growth over the past three years

Page 11: Compensation gaps among top executives: the role of the peer groups

Variables (Cont.)

Control variables Incentive variables CEO pay growth CEO tenure CEO alignment Executives alignment Firm characteristics variables Lagged assets Lagged market-to-book ratio R&D intensity

Page 12: Compensation gaps among top executives: the role of the peer groups

Descriptive statistics

Executives pay is substantially higher in larger firms.

Industry-size above the peer median Industry-size below the peer median Diff.

Compensation level

CEO_Total 6673.24(9188)

2906.11(4967)

3767.12***

CEO_ST 1793.26(9188)

841.50(4967)

951.76***

CEO_LT 4879.98(5287)

2064.61(4374)

2815.37***

Executives_Total 2376.06(37418)

1040.55(19653)

1335.51***

Executives_ST 792.85(37418)

377.32(19653)

415.53***

Executives_LT 1583.21(22396)

663.23(17645)

919.98***

Notes: Figures in parenthesis are observations. *** Significant at the 1% level.

Page 13: Compensation gaps among top executives: the role of the peer groups

Descriptive statistics (Cont.)

Compensation gaps between CEO and other executives are substantial.

Industry-size above the peer median Industry-size below the peer median Diff.

Compensation gap (dollar term, in thousand)

Total gap 4594.06(9188)

1995.24(4967)

2598.82***

Short term gap 1056.24(9188)

489.57(4967)

566.67***

Long term gap 3551.69(9188)

1151.50(4967)

2040.19***

Compensation gap (ratio)

Total gap 3.31(9188)

3.08(4967)

0.24***

Short term gap 2.52(9187)

2.32(4967)

0.19***

Long term gap 4.67(9188)

4.49(4967)

0.18

Notes: Figures in parenthesis are observations. *** Significant at the 1% level.

Page 14: Compensation gaps among top executives: the role of the peer groups

Regression results on size peers

Tournament effect is more significant and the magnitude is larger for the small size peer.

Total Gap Short-term Gap Long-term GapSize above peer group median

Size below peer group median

Size above peer group median

Size below peer group median

Size above peer group median

Size below peer group median

VP_Num 0.023* 0.044*** -0.007 0.008 0.035** 0.051**(0.013) (0.016) (0.013) (0.015) (0.017) (0.024)

CEO_Alignment 0.000 0.007*** -0.006** 0.005*** -0.000 0.005*(0.002) (0.002) (0.003) (0.002) (0.003) (0.003)

VP_Alignment -0.038* -0.068*** -0.024 -0.062*** -0.049* -0.086***(0.019) (0.010) (0.015) (0.011) (0.026) (0.013)

CEO_Tenure 0.007 -0.039*** 0.073*** 0.062*** -0.024* -0.074***(0.011) (0.014) (0.013) (0.015) (0.014) (0.021)

Lag_Assets 0.020*** 0.065*** -0.012 0.024* 0.010 0.045**(0.006) (0.012) (0.009) (0.013) (0.008) (0.018)

Lag_MTB 0.001 0.010** -0.031** -0.004 -0.013** 0.001(0.006) (0.004) (0.013) (0.003) (0.006) (0.005)

R&D_Intensity -0.025* 0.019 -0.088*** -0.039 -0.035* 0.074**(0.014) (0.021) (0.022) (0.024) (0.019) (0.031)

Constant 0.808*** 0.376*** 1.051*** 0.632*** 1.109*** 0.518***(0.103) (0.109) (0.121) (0.132) (0.142) (0.165)

Observations 6,498 3,654 6,488 3,641 6,498 3,654Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.053 0.105 0.051 0.139 0.046 0.079Adj R_squ 0.0422 0.0874 0.0404 0.122 0.0350 0.0605

Page 15: Compensation gaps among top executives: the role of the peer groups

Regression results on size peers (Cont.)

Productivity effect is significant for the large size peer.

Total Gap Short-term Gap Long-term GapSize above peer group

medianSize below peer group

medianSize above peer group median

Size below peer group median

Size above peer group median

Size below peer group median

VP_Pay_Growth 0.000 0.000 -0.000* 0.000 -0.000 0.000(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Vp_Tenure -0.137*** -0.056 -0.064* -0.015 -0.155*** -0.103*(0.026) (0.039) (0.038) (0.030) (0.036) (0.059)

CEO_pay_Growth 0.000*** 0.000*** 0.000 -0.000 0.000*** 0.000**(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

CEO_Alignment -0.002 0.002 -0.008** 0.005** -0.003 0.000(0.002) (0.003) (0.003) (0.002) (0.003) (0.004)

VP_Alignment -0.018 -0.068*** -0.006 -0.057*** -0.024 -0.085***(0.017) (0.010) (0.012) (0.008) (0.023) (0.014)

CEO_Tenure 0.108*** 0.045 0.128*** 0.047** 0.088*** 0.063(0.015) (0.028) (0.021) (0.022) (0.021) (0.041)

Lag_Assets 0.024*** 0.075*** -0.021 0.056*** 0.015 0.044*(0.008) (0.017) (0.016) (0.011) (0.011) (0.026)

Lag_MTB 0.001 0.009 -0.028 0.003 -0.010 -0.004(0.006) (0.007) (0.020) (0.004) (0.007) (0.010)

R&D_Intensity -0.048** 0.006 -0.140*** -0.025 -0.059** 0.051(0.019) (0.028) (0.041) (0.021) (0.027) (0.043)

Constant 1.014*** 0.543*** 1.133*** 0.444*** 1.406*** 0.930***(0.114) (0.141) (0.178) (0.080) (0.163) (0.200)

Observations 3,454 1,654 3,452 1,653 3,454 1,654Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.092 0.200 0.072 0.290 0.072 0.142Adj R_squ 0.0729 0.165 0.0525 0.260 0.0523 0.105

Page 16: Compensation gaps among top executives: the role of the peer groups

Regression results on CEO compensation peers

Tournament proxy is significant for the low CEO pay peer.

Total Gap Short-term Gap Long-term GapCEO pay above peer

group medianCEO pay below peer

group medianCEO pay above peer

group medianCEO pay below

peer group medianCEO pay above peer

group medianCEO pay below peer

group median

VP_Num 0.024 0.038*** 0.006 0.001 0.038 0.048***(0.019) (0.012) (0.022) (0.011) (0.024) (0.017)

CEO_Alignment 0.007** 0.002 -0.002 -0.000 0.008* 0.000(0.003) (0.002) (0.004) (0.001) (0.004) (0.002)

VP_Alignment -0.044 -0.058*** -0.022 -0.050*** -0.062 -0.072***(0.031) (0.009) (0.023) (0.009) (0.042) (0.012)

CEO_Tenure 0.046** -0.056*** 0.071** 0.046*** 0.052* -0.098***(0.019) (0.009) (0.030) (0.009) (0.026) (0.014)

Lag_Assets 0.017** 0.043*** -0.009 0.018*** 0.005 0.030***(0.007) (0.006) (0.012) (0.006) (0.010) (0.008)

Lag_MTB -0.007 0.005 -0.022*** -0.015** -0.016** -0.008(0.006) (0.005) (0.008) (0.007) (0.007) (0.006)

R&D_Intensity -0.015 -0.016 -0.094*** -0.068*** -0.005 -0.001(0.019) (0.015) (0.035) (0.017) (0.026) (0.021)

Constant 0.827*** 0.582*** 1.115*** 0.693*** 1.010*** 0.804***(0.151) (0.079) (0.163) (0.081) (0.206) (0.115)

Observations 3,431 6,721 3,428 6,701 3,431 6,721Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.087 0.062 0.054 0.060 0.082 0.049Adj R_squ 0.0675 0.0515 0.0344 0.0498 0.0627 0.0385

Page 17: Compensation gaps among top executives: the role of the peer groups

Regression results on CEO compensation peers (Cont.)

Productivity proxy is significant for the high and low CEO pay peers.

Total Gap Short-term Gap Long-term GapCEO pay above peer

group medianCEO pay below peer

group medianCEO pay above

peer group medianCEO pay below peer

group medianCEO pay above peer

group medianCEO pay below peer

group median

VP_Pay_Growth -0.000 0.000 -0.000*** -0.000 -0.000 0.000(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

VP_Tenure -0.094** -0.136*** 0.016 -0.094*** -0.143*** -0.151***(0.041) (0.025) (0.053) (0.029) (0.055) (0.037)

CEO_pay_Growth 0.000 0.000*** 0.000 -0.000 0.000 0.000***(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

CEO_Alignment 0.008* -0.003 -0.005 -0.002 0.007 -0.005(0.004) (0.002) (0.007) (0.002) (0.005) (0.003)

VP_Alignment -0.024 -0.051*** -0.001 -0.045*** -0.033 -0.065***(0.025) (0.010) (0.014) (0.009) (0.034) (0.015)

CEO_Tenure 0.128*** 0.057*** 0.108* 0.095*** 0.172*** 0.030(0.030) (0.015) (0.057) (0.013) (0.044) (0.022)

Lag_Assets 0.018** 0.049*** -0.025 0.020** 0.005 0.039***(0.009) (0.007) (0.019) (0.008) (0.012) (0.011)

Lag_MTB -0.012* 0.004 -0.028 -0.011** -0.025*** -0.018*(0.007) (0.008) (0.019) (0.006) (0.009) (0.011)

R&D_Intensity -0.052** -0.031 -0.157** -0.087*** -0.057 -0.025(0.026) (0.021) (0.062) (0.026) (0.036) (0.030)

Constant 1.160*** 0.932*** 1.292*** 0.683*** 1.445*** 1.388***(0.201) (0.096) (0.240) (0.074) (0.303) (0.137)

Observations 1,989 3,119 1,988 3,117 1,989 3,119Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.094 0.116 0.070 0.103 0.092 0.088Adj R_squ 0.0610 0.0955 0.0364 0.0825 0.0592 0.0674

Page 18: Compensation gaps among top executives: the role of the peer groups

Regression results on non-CEO executives compensation peers

Tournament proxy is significant for the high and low non-CEO executives pay peers.

Total Gap Short-term Gap Long-term GapVP pay above peer

group medianVP pay below peer

group medianVP pay above peer

group medianVP pay below peer

group medianVP pay above peer

group medianVP pay below peer

group median

VP_Num 0.216*** 0.209*** 0.116*** 0.098*** 0.274*** 0.301***(0.018) (0.012) (0.016) (0.012) (0.026) (0.019)

CEO_Alignment 0.076*** 0.040*** 0.054*** 0.022*** 0.065*** 0.037***(0.017) (0.007) (0.013) (0.006) (0.022) (0.008)

VP_Alignment -0.032 -0.014 -0.015 -0.009 0.009 0.004(0.025) (0.014) (0.021) (0.009) (0.036) (0.019)

CEO_Tenure -0.003 -0.077*** -0.012 -0.008 -0.019 -0.116***(0.015) (0.010) (0.013) (0.008) (0.023) (0.015)

Lag_Assets 0.014** 0.026*** 0.017*** 0.008 -0.004 -0.005(0.006) (0.006) (0.005) (0.005) (0.009) (0.009)

Lag_MTB 0.007** 0.020*** 0.001 0.001 -0.008 0.004(0.004) (0.004) (0.002) (0.009) (0.005) (0.006)

R&D_Intensity 0.025 0.030** 0.016 -0.003 0.030 0.044*(0.019) (0.015) (0.015) (0.012) (0.029) (0.023)

Constant -0.344** -0.361*** 0.001 0.116 -0.173 -0.245*(0.136) (0.085) (0.117) (0.075) (0.266) (0.127)

Observations 3,792 6,375 3,790 6,359 3,792 6,375Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.163 0.142 0.170 0.087 0.113 0.110Adj R_squ 0.148 0.132 0.154 0.0768 0.0960 0.0999

Page 19: Compensation gaps among top executives: the role of the peer groups

Regression results on non-CEO executives compensation peers (Cont.)

Productivity proxy is generally not significant for the high and low non-CEO peers.

Total Gap Short-term Gap Long-term GapVP pay above peer

group medianVP pay below peer

group medianVP pay above peer

group medianVP pay below peer

group medianVP pay above peer

group medianVP pay below peer

group median

VP_Pay_Growth -0.001* 0.000 -0.000 -0.001*** -0.001* 0.000(0.001) (0.001) (0.000) (0.000) (0.001) (0.001)

VP_Tenure 0.029 -0.014 0.014 0.020 -0.010 -0.057(0.048) (0.031) (0.036) (0.024) (0.064) (0.045)

CEO_pay_Growth 0.001* 0.000 0.000 0.001*** 0.001* 0.000(0.001) (0.001) (0.000) (0.000) (0.001) (0.001)

CEO_Alignment 0.067*** 0.032*** 0.048*** 0.021*** 0.066*** 0.030***(0.019) (0.009) (0.016) (0.006) (0.024) (0.010)

VP_Alignment -0.031 -0.019 -0.022 -0.009 -0.011 -0.014(0.029) (0.014) (0.024) (0.010) (0.039) (0.015)

CEO_Tenure -0.063*** -0.073*** -0.056*** -0.021 -0.077** -0.105***(0.024) (0.022) (0.020) (0.017) (0.033) (0.033)

Lag_Assets 0.025** 0.046*** 0.008 0.016** 0.020 0.033**(0.010) (0.009) (0.008) (0.007) (0.013) (0.013)

Lag_MTB 0.009 -0.003 0.003 -0.016** -0.004 -0.035**(0.006) (0.011) (0.004) (0.007) (0.008) (0.015)

R&D_Intensity -0.014 0.056** 0.015 0.028 -0.034 0.043(0.029) (0.028) (0.022) (0.019) (0.040) (0.040)

Constant 0.710*** 0.412*** 0.389*** 0.433*** 1.167*** 0.878***(0.213) (0.112) (0.090) (0.103) (0.345) (0.164)

Observations 1,672 2,341 1,671 2,337 1,672 2,341Year dummies and industry fixed effects

Yes Yes Yes Yes Yes Yes

R-squared 0.188 0.130 0.222 0.141 0.132 0.101Adj R_squ 0.153 0.103 0.188 0.115 0.0942 0.0732

Page 20: Compensation gaps among top executives: the role of the peer groups

Conclusions

This paper examines the role of the peer group on the tournament and productivity effect of the compensation gaps.

Major findings Productivity differentials are observed in the large size peer and high CEO

compensation peer. Tournament effect is observed in the small size peer and the pay gap among

non-CEO executives.

Our findings could help reconcile the debate on the tournament and productivity effect of the compensation gaps of top executives.

Page 21: Compensation gaps among top executives: the role of the peer groups

Thank You!