(Why) Are US CEOs Paid More?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday December 10, 2012 at 8:54 am
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Editor’s Note: The following post comes to us from Nuno Fernandes, Professor of Finance at IMD Business School; Miguel Ferreira, Professor of Finance at Nova School of Business and Economics; Pedro Matos, Associate Professor of Business Administration at the University of Virginia, Darden School of Business; and Kevin Murphy, Professor of Finance at the University of Southern California, Marshall School of Business.

The high pay of U.S. CEOs relative to their foreign counterparts has been cited as evidence of excesses in U.S. executive compensation practices. This perception of a “pay divide” between the United States and the rest of the world is usually based on estimates provided by professional services firms like Towers Watson that receive a good deal of press coverage. However, attempts to understand the magnitude and determinants of the U.S. pay premium have been plagued by data limitations due to international differences in rules regulating the disclosure of executive compensation.

In our paper, Are U.S. CEOs Paid More? New International Evidence, forthcoming in the Review of Financial Studies, we use new data to compare CEO pay in 1,648 U.S. firms versus 1,615 firms from 13 foreign countries. Thanks to recently expanded disclosure rules, our sample includes publicly listed firms from both Anglo-Saxon and continental European countries that had mandated disclosure of CEO pay by 2006. It covers nearly 90% of the market capitalization of firms in these markets and, importantly, comprises firms with different corporate governance arrangements.

This new data shows that the conventional wisdom is wrong. We find that the U.S. pay premium is economically modest after we control for firm, ownership, and board characteristics. At the onset, U.S. CEOs earn, on average, approximately double the pay of non-U.S. CEOs in our sample. This is in line with aggregate estimates by professional services firms. However, this is comparing apples to oranges, since U.S. firms are different in many ways from international firms. Using firm-level data, we estimate an average pay premium of only 26% after we control for characteristics like firm size and, more importantly, ownership and board structure in which U.S. firms are systemically different. U.S. firms tend to have higher institutional ownership and more independent boards, factors that we find to be associated with both higher pay and a larger fraction of pay being awarded in the form of stock options or restricted stock. In contrast, shareholdings in U.S. firms tend to be less dominated by “insiders” (such as large-block family shareholders), a factor we find to be associated with lower pay and reduced use of equity-based compensation.

Our study shows that a bigger fraction of U.S. CEO pay packages is equity-based pay which the executive gets only if shareholder value is created. This suggests that comparisons made in the press on the level of pay should not be looked at in isolation, without also examining differences in the structure of pay. In addition, we believe that the fact that CEO pay is more tied to shareholder performance when firms are held more by institutional owners and monitored by independent board members is a symptom of good corporate governance. This calls into question the characterization of the levels of U.S. CEO pay as “excessive.”

We examine detailed biographical data on each CEO and find some interesting non-results. For instance, we find that the U.S. pay premium was not attributable to U.S. CEOs being special in terms of age, tenure, education, or past experience.

Finally, we explore the factors contributing to the convergence of CEO pay practices internationally in the last decade. Many of the firms in our non-U.S. sample compete in the global market for capital, customers, and managerial talent. We show that there is not a significant difference in CEO pay between U.S. firms and non-U.S. firms exposed to international markets. Overall, we document that foreign firms attempting to attract executives in competition with equivalent U.S. firms are offering packages that are competitive with U.S. levels. For example, foreign firms that are cross-listed on a U.S. exchange, have a high presence of U.S. institutions as shareholders, have U.S. operations, or have directors who also serve on U.S. boards have seen their pay practices converge toward U.S. Standards.

Our evidence is inconsistent with the view that U.S. CEO pay is “excessive” as we find that CEO pay levels and the use of equity-based compensation are positively related to variables routinely used as proxies for better monitoring and better “shareholder-centric” governance — namely, institutional ownership and board independence. If U.S. firms had poor governance, we would expect U.S. CEOs to pay themselves higher “safe” base salaries instead of self-imposing higher performance-based pay.

The full paper is available for download here.

 

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