_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 4, No. 12: June 19, 2003
_________________________________________________________________
Publisher: LSN Employment, Labor, Compensation & Pension Journals
a division of
Social Science Electronic Publishing, Inc. (SSEP)
and Social Science Research Network (SSRN)
Editor: PAMELA PERUN
Urban Institute
Mailto:pamela@planetnow.com
Copyright: SSEP, Inc. 2003. All rights reserved.
Leading Social Science Research Delivered To Your Desktop
http://www.SSRN.Com/
___________________________________________________________
Topic of This Issue:
Executive Compensation
___________________________________________________________
SEARCHING THE SSRN ELECTRONIC LIBRARY
To search the entire SSRN Electronic Library by author, title,
JEL code, or full text of the abstracts in our database, please
visit http://papers.ssrn.com/
To browse all abstracts published in this journal, please visit
http://www.ssrn.com/link/benefits-compensation-pension-law.html
REDISTRIBUTION
Individual and professional subscriptions to the journal are for
single users. It is a violation of copyright to redistribute
this document electronically or otherwise without the explicit
permission of Social Science Electronic Publishing, Inc.
Site licenses for organizations are available by contacting
Mailto:Site@SSRN.Com
SIGN OFF
To stop delivery of one or more of the SSRN journals, write to
Mailto:Remove@SSRN.Com Include the JOURNAL name or the NETWORK
name or ALL in the subject line. If your address has changed, let
us know by writing to Mailto:AddressChg@SSRN.Com
ALIGNMENT
If this document is misaligned, please set type face to a
non-proportional font such as Courier 10.
PAPER DOWNLOADS
If you need assistance downloading papers from our web site,
please contact Mailto:Support@SSRN.Com
T A B L E of C O N T E N T S
_________________________________________________________________
NEW and FORTHCOMING ARTICLES
"Explaining the International CEO Pay Gap: Board Capture or
Market Driven?"
Vanderbilt Law Review, 2003
RANDALL S. THOMAS
Vanderbilt University School of Law
WORKING PAPERS
"Executive Compensation and Corporate Fraud"
SHANE A. JOHNSON
Louisiana State University
E.J. Ourso College of Business Administration
HARLEY E. RYAN
Louisiana State University
E.J. Ourso College of Business Administration
YISONG SAM TIAN
York University
Schulich School of Business
"Executive Compensation and Short-termist Behavior in Speculative
Markets"
PATRICK BOLTON
Princeton University
Department of Economics
European Corporate Governance Institute (ECGI)
National Bureau of Economic Research (NBER)
Centre for Economic Policy Research (CEPR)
JOSE A. SCHEINKMAN
Princeton University - Department of Economics
WEI XIONG
Princeton University - Department of Economics
"When is Enough, Enough? Market Reaction to Highly Dilutive Stock
Option Plans and the Subsequent Impact on CEO Compensation"
KENNETH J. MARTIN
New Mexico State University
Department of Finance
RANDALL S. THOMAS
Vanderbilt University School of Law
"Executive Compensation and Managerial Risk-Taking"
JEFFREY L. COLES
Arizona State University
NAVEEN D. DANIEL
Georgia State University
Department of Finance
LALITHA NAVEEN
Georgia State University
Department of Finance
"Independent Directors, Executive Pay, and Firm Performance"
KAM-MING WAN
University of Texas at Dallas
School of Management
"Executive Pay: Prior Successes and Future Incentives"
CHRISTIAN LUKAS
Otto-von-Guericke-University Magdeburg - Faculty of
Economics & Management
S S R N I N F O R M A T I O N
_________________________________________________________________
* Partners in Publishing
* Administrative Information
- Missing issues & change of address
- Solicitation of abstracts
* Directors
* Subscription to SSRN Journals
_________________________________________________________________
ACQUIRING PAPERS
Download papers directly from the included web address or contact
the author or other contact person directly. Provide an address
to which the author or other contact person can send a paper
copy and mention that you saw the abstract in SSRN. Some of
SSRN's Partners in Publishing require a subscription or charge a
fee for electronic downloads.
EDITORIAL POLICIES
To provide the broadest coverage of research in Employee
Benefits, Compensation & Pension Law we do not referee working
papers. We accept abstracts of working papers in Employee
Benefits, Compensation & Pension Law whose topics suit the
coverage of the journal and which are part of the worldwide
scholarly discourse.
N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"Explaining the International CEO Pay Gap: Board Capture or
Market Driven?"
Vanderbilt Law Review, 2003
BY: RANDALL S. THOMAS
Vanderbilt University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=407600
Paper ID: Vanderbilt Law and Economics Research Paper No. 03-05
Contact: RANDALL S. THOMAS
Email: Mailto:randall.thomas@law.vanderbilt.edu
Postal: Vanderbilt University School of Law
131 21st Avenue South
Nashville, TN 37203-1181 UNITED STATES
Phone: 615-343-3814
Fax: 615-322-6631
Paper Requests:
Contact: Janis Stewart, Joe C. Davis Working Paper Series
Program, Vanderbilt University Law School, 131 21st Avenue
South, Nashville, TN 37203. Phone:(615) 322-0028. Fax:(615)
322-6631. Mailto:Janis.Stewart@law.vanderbilt.edu
ABSTRACT:
One of the most puzzling aspects of executive compensation is
the pay gap that exists between American and foreign Chief
Executive Officers (CEOs). Commentators and the financial press
have been quick to argue that such differences are the result of
high agency costs, or "board capture," a theory that claims
powerful American executives take advantage of weak domestic
boards of directors and passive, dispersed shareholders to
overpay themselves exorbitantly. According to these theorists,
American CEOs orchestrate the appointments of friendly, passive
outside directors, and their obedient subordinates as inside
directors. The net result is a board comprised of compliant
directors and a Compensation Committee that lacks the aggressive
hard-nosed negotiators needed to keep executive pay in check.
The international pay gap arises, under this theory, because
foreign CEOs don't have the same power over their boards. In
most foreign corporations, control shareholders act as strong
checks on executive pay. Control shareholders will recoup most
of the firm's surplus that is not paid out to the factors of
production, such as CEOs, and therefore have strong financial
incentives to keep executive pay abroad low. Thus, by comparison
to U.S. levels, foreign CEOs are paid less.
In this article, I am critical of the board capture
explanation and offer several more plausible, market-based
explanations. Board capture, while it may lead to some inflation
in U.S. CEO pay levels, it does not fully explain CEO pay
levels. For example, it does not tell us why executive pay in
the U.S. grew so rapidly after the early 1980's. There is no
evidence that CEOs' power over their boards grew during this
time period; in fact, most evidence is to the contrary. Nor does
this theory offer a persuasive explanation of why bigger firms
pay their executives more than smaller ones, or why the supply
of executives has not dramatically increased in response to the
alleged huge rents that CEOs have been receiving for the last
twenty years. Furthermore, board capture does not explain why
boards pay incoming CEOs so much where they have no prior
relationship with the directors. Finally, even if we accept the
theory, we still will need a mechanism to set executive pay.
Market-driven forces seem necessary to accomplish this result.
I offer four alternative market-based justifications for
higher pay for American CEOs. The first rests on the marginal
revenue product of executive labor. American CEOs should be paid
more, on average, than foreign CEOs because American CEOs
contribute more to their firms' value. American firms have
greater growth opportunities, have greater resources to be
deployed because they are bigger, and American CEOs play a much
larger role in the decision-making process at their firms than
CEOs at foreign firms. Furthermore, American CEOs receive more
of their pay in the form of stock options, and may hold more of
their wealth in company stock, than foreign CEOs and therefore
their pay will reflect a risk premium.
Next, I examine the international pay gap by examining the
workings of corporations' internal labor markets and tournament
theory. The tournament to become the CEO is, under this theory,
a much bigger one at American firms because these CEOs have so
much more power than their foreign counterparts. After all, in
the U.S., the CEO is normally also the Chairman of the Board,
whereas in foreign countries this is rarely the case. American
CEOs' power is further enhanced compared to those of their
biggest foreign rivals, Japan and Germany, because boards of
directors are smaller in the U.S. than in Japan, and have only
one tier, instead of the two tier structure in Germany.
Furthermore, the "winner take all" culture in the U.S. may
condone bigger prizes in these tournaments than are socially
acceptable abroad.
Third, I show that there are differences in the opportunity
costs for American and foreign CEOs. The opening up of financial
markets since the early 1980s has given U.S. CEOs better access
to capital markets for financing their own start-up businesses,
raising the value of their alternative opportunities. This
occurred first through the use of the leveraged buyout (LBO) as
a method of financing a new firm, then with the tremendous
growth in venture capital financing, and later on (at least for
a period of years) when the technology boom made available
massive amounts of capital to finance start-ups. Established
American businesses that wished to compete for managerial talent
were thereby forced to offer executives larger pay packages.
By comparison, foreign CEOs have not had nearly the same
access to financial markets to launch their own businesses.
Foreign financial markets are more fragmented, more regulated,
offer less venture capital financing and experience fewer MBOs.
Only recently has there been an expansion of executive job
opportunities with the deregulation of some capital markets and
increased managerial migration. These changes have increased
pressure on foreign companies to pay their executives more like
Americans, but they have yet to catch up.
Finally, there are big differences in the amount of bargaining
power that American CEOs have compared to that of foreign CEOs.
These differences derive from two important forces at work in
the U.S.: first, the shift in the 1980's in the relative
bargaining strength of American CEOs in vetoing takeovers of
their corporations; and second, the concurrent acceptance of the
idea of pay-for-performance by domestic institutional investors.
These changes gave American CEOs tremendous power to stop a
hostile takeover unless the sale of the firm was perceived as in
that executive's personal best interests.
Top managers of foreign firms have not enjoyed the same
increase in bargaining power because, while hostile takeovers in
most foreign countries continue to be almost impossible to pull
off, these firms generally have control shareholder ownership
structures. Thus, in foreign firms control shareholders make the
decision whether or not to sell the company. There is no reason
for the dominant shareholder to offer the firm's CEO more money
for agreeing to a sale, unless the CEO happens to be the control
shareholder himself.
JEL Classification: K22, J30, J31, J33, J40, M21, M52
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Executive Compensation and Corporate Fraud"
BY: SHANE A. JOHNSON
Louisiana State University
E.J. Ourso College of Business Administration
HARLEY E. RYAN
Louisiana State University
E.J. Ourso College of Business Administration
YISONG SAM TIAN
York University
Schulich School of Business
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=395960
Date: April 16, 2003
Contact: SHANE A. JOHNSON
Email: Mailto:SHANE@LSU.EDU
Postal: Louisiana State University
E.J. Ourso College of Business Administration
CEBA Bldg
Baton Rouge, LA 70803-6308 UNITED STATES
Phone: 225-578-0477
Fax: 225-578-6366
Co-Auth: HARLEY E. RYAN
Email: Mailto:CRYAN@LSU.EDU
Postal: Louisiana State University
E.J. Ourso College of Business Administration
2163 CEBA
Baton Rouge, LA 70803-6308 UNITED STATES
Co-Auth: YISONG SAM TIAN
Email: Mailto:ytian@ssb.yorku.ca
Postal: York University
Schulich School of Business
4700 Keele Street
Toronto, Ontario M3J 1P3 CANADA
ABSTRACT:
We examine the relation between executive compensation and
corporate fraud. Executives at fraud firms have significantly
larger equity-based compensation and greater financial
incentives to commit fraud than do executives at industry- and
size-matched control firms. Executives at fraud firms also earn
significantly more total compensation by exercising
significantly larger fractions of their vested options than the
control executives during the fraud years. Operating and stock
performance measures suggest executives who commit corporate
fraud attempt to offset declines in performance that would
otherwise occur. Our results imply that optimal governance
measures depend on the strength of executives' financial
incentives.
Keywords: corporate fraud, incentives, stock options,
executive compensation, governance
JEL Classification: G30, K00, M40, M52
______________________________
"Executive Compensation and Short-termist Behavior in Speculative
Markets"
BY: PATRICK BOLTON
Princeton University
Department of Economics
European Corporate Governance Institute (ECGI)
National Bureau of Economic Research (NBER)
Centre for Economic Policy Research (CEPR)
JOSE A. SCHEINKMAN
Princeton University - Department of Economics
WEI XIONG
Princeton University - Department of Economics
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=391881
Other Electronic Document Delivery:
http://www.princeton.edu/~wxiong/papers/ceo.pdf
SSRN only offers technical support for papers
downloaded from the SSRN Electronic Paper Collection
location. When URLs wrap, you must copy and paste
them into your browser eliminating all spaces.
Date: March 26, 2003
Contact: WEI XIONG
Email: Mailto:wxiong@princeton.edu
Postal: Princeton University - Department of Economics
26 Prospect Avenue
Princeton, NJ 08540 UNITED STATES
Co-Auth: PATRICK BOLTON
Email: Mailto:PBOLTON@PRINCETON.EDU
Postal: Princeton University
Department of Economics
Fisher Hall, 306
Princeton, NJ 08544 UNITED STATES
Co-Auth: JOSE A. SCHEINKMAN
Email: Mailto:joses@princeton.edu
Postal: Princeton University - Department of Economics
307 Fisher Hall
Princeton, NJ 08544 UNITED STATES
ABSTRACT:
We present a multiperiod agency model of stock based executive
compensation in a speculative stock market, where investors are
overconfident and stock prices may deviate from underlying
fundamentals and include a speculative option component. This
component arises from the option to sell the stock in the future
to potentially overoptimistic investors. We show that optimal
compensation contracts may emphasize short-term stock
performance, at the expense of long run fundamental value, as an
incentive to induce managers to pursue actions which increase
the speculative component in the stock price. Our model provides
a different perspective for the recent corporate crisis than the
increasingly popular 'rent extraction view' of executive
compensation.
Keywords: Executive Compensation, Short-term Behavior,
Speculative Market, Corporate Governance
______________________________
"When is Enough, Enough? Market Reaction to Highly Dilutive Stock
Option Plans and the Subsequent Impact on CEO Compensation"
BY: KENNETH J. MARTIN
New Mexico State University
Department of Finance
RANDALL S. THOMAS
Vanderbilt University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=407620
Paper ID: Vanderbilt Law and Economics Research Paper No. 03-06
Date: February 2003
Contact: RANDALL S. THOMAS
Email: Mailto:randall.thomas@law.vanderbilt.edu
Postal: Vanderbilt University School of Law
131 21st Avenue South
Nashville, TN 37203-1181 UNITED STATES
Phone: 615-343-3814
Fax: 615-322-6631
Co-Auth: KENNETH J. MARTIN
Email: Mailto:kjmartin@nmsu.edu
Postal: New Mexico State University
Department of Finance
College of Business Administration & Economics
Las Cruces, NM 88003 UNITED STATES
Paper Requests:
Contact: Janis Stewart, Joe C. Davis Working Paper Series
Program, Vanderbilt University Law School, 131 21st Avenue
South, Nashville, TN 37203. Phone:(615) 322-0028. Fax:(615)
322-6631. Mailto:Janis.Stewart@law.vanderbilt.edu
ABSTRACT:
Early studies of market reaction to stock option plans have
found positive increases in stock prices upon the announcement
of these plans. However, since in the mid-1990's, shareholders
have become increasingly critical of stock option plans, and
voted against them in growing numbers. Are shareholders fed up
with the continued growth in option compensation, and if so,
what are boards of directors doing in response to these
concerns?
In this paper, we use data from the 1998 proxy season to
reevaluate market reaction to management-sponsored proposals for
stock option plans, the level of shareholder opposition to these
plans, and the effect of this opposition on corporate boards'
awards of CEO compensation in subsequent years. In the first
half of the paper, we conduct an event study similar to those
done for early stock option plans from the 1980's and early
1990's. However, we expect to find that the market will react
differently to plans that exhibit the high levels of potential
dilution of shareholder ownership and certain "shareholder
unfriendly" aspects of the plans that make shareholders more
likely to vote against such plans. Our findings support part of
our hypothesis: we find that higher levels of potential dilution
in executive-only plans result in significantly negative
cumulative abnormal returns in the 3-day period surrounding the
proxy date, but that plans that include repricing provisions,
permit executives to borrow money from the firm in order to
exercise options, or that allow the issuance of restricted
stock, do not experience significantly negative returns.
In the second part of the paper, we present evidence regarding
the factors that affect shareholder voting opposition to stock
option plans and the impact of this opposition on subsequent CEO
compensation. In cross-sectional regressions, we find a
significantly negative relationship between the percentage vote
against the option proposal and the percentage change in salary
and in total pay from the 1998 to 1999 compensation years. We
interpret this finding to support the idea that boards of
directors respond to shareholder concerns about CEO option
awards by reducing executive pay in the year after a high level
of shareholder opposition.
JEL Classification: K22, J30, J33, J40, M21, M52
______________________________
"Executive Compensation and Managerial Risk-Taking"
BY: JEFFREY L. COLES
Arizona State University
NAVEEN D. DANIEL
Georgia State University
Department of Finance
LALITHA NAVEEN
Georgia State University
Department of Finance
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=391102
Paper ID: Arizona State University and Georgia State University
Working Paper
Date: January 24, 2003
Contact: LALITHA NAVEEN
Email: Mailto:LALITHA@GSU.EDU
Postal: Georgia State University
Department of Finance
University Plaza
Atlanta, GA 30303-3083 UNITED STATES
Co-Auth: JEFFREY L. COLES
Email: Mailto:jeffrey.coles@asu.edu
Postal: Arizona State University
W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906 UNITED STATES
Co-Auth: NAVEEN D. DANIEL
Email: Mailto:NAV@GSU.EDU
Postal: Georgia State University
Department of Finance
College of Business Administration
35 Broad St, Suite 1221
University Plaza
Atlanta, GA 30303-3083 UNITED STATES
ABSTRACT:
This paper provides empirical evidence of a strong relation
between the structure of managerial compensation and both
investment policy and debt policy. Higher sensitivity of CEO
wealth to stock volatility (vega) is associated with riskier
policy choices, including relatively more investment in R&D,
more focus on fewer lines of business, and higher leverage.
These results are consistent with the hypothesis that higher
vega in the managerial compensation scheme gives executives the
incentive to implement policy choices that increase risk. Our
results also indicate that these investment and financial policy
choices are among the primary mechanisms through which vega
affects stock price volatility.
Keywords: executive compensation, managerial compensation,
risk-taking, investment policy, debt policy, incentives
JEL Classification: G31, G32, G34, J33
______________________________
"Independent Directors, Executive Pay, and Firm Performance"
BY: KAM-MING WAN
University of Texas at Dallas
School of Management
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=392595
Paper ID: EFMA 2003 Helsinki Meetings
Contact: KAM-MING WAN
Email: Mailto:kmwan@utdallas.edu
Postal: University of Texas at Dallas
School of Management
Finance and Managerial Economics
P.O. Box 830688
Richardson, TX 75083-0688 UNITED STATES
Phone: 972-883-2718
Fax: 972-883-2799
ABSTRACT:
In the wake of the recent runaway executive compensation and
corporate scandals, professions in many circles are calling for
more representation by independent directors in American
boardrooms. This paper examines the question of whether such
directors could reduce executive pay and enhance corporate
performance. Using a sample of the largest U.S. corporations, I
find that firm and industry differences alone explain most of
the variation in executive pay. My results also indicate that
ownership and board characteristics have little impact on
executive pay. In particular, managers are not paid less and
corporate performances are not improved for boards with more
representation by independent directors. This paper has policy
implications regarding the recent proposed change in listing
requirements in the NYSE and Nasdaq.
Keywords: Executive Compensation, Independent Directors, Stock
Options
JEL Classification: G32, J33
______________________________
"Executive Pay: Prior Successes and Future Incentives"
BY: CHRISTIAN LUKAS
Otto-von-Guericke-University Magdeburg - Faculty of
Economics & Management
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=391260
Paper ID: FEMM Working Paper Series No. 03/2003
Date: March 2003
Contact: CHRISTIAN LUKAS
Email: Mailto:lukas@ww.uni-magdeburg.de
Postal: Otto-von-Guericke-University Magdeburg - Faculty of
Economics & Management
Universitaetsplatz 2
39106 Magdeburg, GERMANY
Phone: ++49-391-6711694
Fax: ++49-391-6711137
ABSTRACT:
Executive compensation has become a field of intense (agency)
theoretical and empirical research. A theoretically rather
unexplored area is the absolute level of pay and what accounts
for differences in absolute pay. In this paper a two-period
agency model is developed to determine a pay structure that
provides incentives for managerial effort and uses informative
signals about the agent's ability. The resulting pay structure
does not always award the most successful agent with the highest
pay. A more risky distribution of the agent's ability generates
a less costly information system.