Posts Tagged ‘Michael Faulkender’

The Dynamics of Compensation Peer Benchmarking

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday December 12, 2012 at 8:58 am
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Editor’s Note: The following post comes to us from Michael Faulkender of the Robert H. Smith School of Business at the University of Maryland and Jun Yang of the Kelley School of Business at Indiana University.

Changes in the level and dispersion of CEO compensation since the early 1990s have triggered an increasingly heated debate over whether current compensation practices primarily reflect the equilibrium outcome of the CEO labor market or the power of entrenched CEOs. One factor in this debate is the practice of compensation benchmarking in which firms justify their CEO’s compensation by comparing it to the pay packages of a group of companies with highly paid CEOs. Firms rationalize this group by claiming they compete for managerial talent with those selected peer companies. In the paper, Is Disclosure an Effective Cleansing Mechanism? The Dynamics of Compensation Peer Benchmarking, forthcoming in the Review of Financial Studies, we examine the dynamics of the peer benchmarking process. Specifically, we investigate whether the 2006 regulation requiring firms to disclose their compensation peer group members has mitigated opportunistic firm behavior in benchmarking against self-selected peer companies with highly paid CEOs.

…continue reading: The Dynamics of Compensation Peer Benchmarking

Compensation Peer Groups

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday June 26, 2009 at 9:18 am
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Editor’s Note: This post comes to us from Michael Faulkender of the University of Maryland and Jun Yang of Indiana University.

In our forthcoming Journal of Financial Economics paper entitled “Inside the black box: the role and composition of compensation peer groups” we investigate how much compensation peer groups explain observed variation in CEO compensation and what determines the composition of these groups. Effective December 15, 2006, the SEC required that firms disclose “Whether the registrant engaged in any benchmarking of total compensation, or any material element of compensation, identifying the benchmark and, if applicable, its components (including component companies).” This study is the first to collect and examine the list of compensation peer companies used by the S&P 500 firms and S&P MidCap 400 firms in their first fiscal year ending after the compliance date of December 15, 2006.

We find that the median compensation of the peer group generates significant incremental explanatory power in understanding cross-sectional variation in the observed CEO compensation among disclosing firms even after including controls for CEO labor market conditions. We find that CEOs whose pay was below the median pay level of their counterparts in companies of similar size and in the same industry receive pay raises that are larger in both percentage and dollar terms. In contrast, having actual compensation peer group membership enables us to demonstrate that peer companies outside the firm’s industry and size group also have a significant influence on executive compensation.

When we examine the composition of peer groups, we find that firms select companies in the same industry, of similar size, and with a history of observed talent flows between them to be members of their compensation peer groups. Using both multivariate probit models and a propensity score matching (PSM) approach, we show that the level of CEO compensation at a potential peer company is statistically significant in determining its likelihood of being chosen as a compensation peer, after controlling for industry, size, visibility, talent flows and CEO characteristics. In other words, compensation committees seem to be endorsing compensation peer groups that include companies with higher CEO compensation, everything else equal, possibly because such peer companies enable justification of the high level of their CEO pay.

One interpretation of our results is that entrenched CEOs in firms with weak corporate governance are likely to have more power to influence their own compensation. An alternative interpretation of our findings is that higher CEO compensation (for more complex firms) is likely to be an equilibrium result in a well-functioning labor market. To distinguish between these two theories, we examine the variation in pay differences between selected and unselected peers across measures of corporate governance. We find that highly paid potential peers are more likely to be chosen as compensation peers by firms where the peer group is smaller, where the CEO is the Chairman of the BOD, where the CEO has been in the post longer, and where directors are busier serving on multiple boards.

The full paper is available for download here.

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