_________________________________________________________________
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. 6, No. 7: April 7, 2005
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Publisher: Employment, Labor, Compensation & Pension Law 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. 2005. All rights reserved.
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Topic of This Issue:
Executive Compensation
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T A B L E of C O N T E N T S
_________________________________________________________________
WORKING PAPERS
"The Managerial Power Thesis Revised: CEO Compensation and the
Independence of Independent CEO Directors"
ALLEN KAUFMAN
University of New Hampshire
Department of Management
ERNIE ENGLANDER
George Washington University
Department of Strategic Management & Public Policy
CHRISTOPHER L. TUCCI
Swiss Federal Institute of Technology Lausanne
(Ecole Polytechnique Federale de Lausanne (EPFL))
"Back Door Links Between Directors and Executive Compensation"
DAVID F. LARCKER
University of Pennsylvania
Accounting Department
SCOTT ANTHONY RICHARDSON
University of Pennsylvania
The Wharton School
ANDREW SEARY
Simon Fraser University
School of Communication
AYSE IREM TUNA
University of Pennsylvania
The Wharton School
"Executive Compensation at Fannie Mae: A Case Study of Perverse
Incentives, Nonperformance Pay, and Camouflage"
LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley - School of Law
"Effects and Unintended Consequences of the Sarbanes-Oxley Act on
Corporate Boards"
JAMES S. LINCK
University of Georgia
Department of Banking and Finance
JEFFRY M. NETTER
University of Georgia
Department of Banking and Finance
TIANXIA YANG
University of Georgia
Department of Banking and Finance
"Do Mutual Fund Managers Monitor Executive Compensation?"
DAVID R. GALLAGHER
University of New South Wales
School of Banking and Finance
GAVIN SMITH
University of New South Wales - School of Banking
and Finance
PETER LAWRENCE SWAN
University of New South Wales
School of Banking and Finance
"Mutual Fund Proxy Votes"
BURTON G. ROTHBERG
City University of New York - Stan Ross Department
of Accountancy
STEVEN B. LILIEN
City University of New York
Stan Ross Department of Accountancy
"Executive Compensation at Fannie Mae and Freddie Mac"
WILLIAM R. EMMONS
Federal Reserve Bank of St. Louis
GREGORY E. SIERRA
Federal Reserve Bank of St. Louis
S S R N I N F O R M A T I O N
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W O R K I N G P A P E R Abstracts
_________________________________________________________________
"The Managerial Power Thesis Revised: CEO Compensation and the
Independence of Independent CEO Directors"
BY: ALLEN KAUFMAN
University of New Hampshire
Department of Management
ERNIE ENGLANDER
George Washington University
Department of Strategic Management & Public Policy
CHRISTOPHER L. TUCCI
Swiss Federal Institute of Technology Lausanne
(Ecole Polytechnique Federale de Lausanne (EPFL))
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=678381
Date: March 3, 2005
Contact: ERNIE ENGLANDER
Email: Mailto:ejeeje@gwu.edu
Postal: George Washington University
Department of Strategic Management & Public
Policy
710 21st Street NW
203 Monroe Hall
Washington, DC 20052 UNITED STATES
Phone: 202-994-8203
Fax: 202-994-8113
Co-Auth: ALLEN KAUFMAN
Email: Mailto:allenkaufman@comcast.net
Postal: University of New Hampshire
Department of Management
Durham, NH 03824 UNITED STATES
Co-Auth: CHRISTOPHER L. TUCCI
Email: Mailto:christopher.tucci@epfl.ch
Postal: Swiss Federal Institute of Technology Lausanne (Ecole
Polytechnique Federale de Lausanne (EPFL))
Station 5
Odyssea 1.04
CH-1015 Lausanne, SWITZERLAND
ABSTRACT:
The corporate scandals that broke at the new millennium
generated heated discussion among scholars and policy makers
about corporate governance with a special animus for executive
compensation. Most scholars agree that the agency costs arising
from the separation of shareholder interests (residual rights)
and managerial interests (control rights) can potentially allow
for managerial malfeasance.
Still, scholars divide on top executives' culpability for
compensation problems. One group argues that optimal contracts
for CEOs can be achieved if board members are better educated
about the actual costs of executive pay (particularly stock
option costs) if modifications are made in accounting rules and
tax policy, and if corporate directors are more independent from
management. Dissenters do not discard these recommendations.
However, this second group of scholars considers CEOs'
conspiratorial powers far greater than optimal contract
theorists. These managerial power proponents consider each
instrument that is proposed to minimize agency costs has its own
potential tools for abuse, i.e., managers can readily convert
the best-intended policies into sources of undeserved managerial
gain.
Yet, managerial power theorists lack a persuasive historical
account on how managers undermined the independent boards
established in the 1990s into self-serving devices. We argue
that the managerial power thesis has omitted key actors who have
emerged in the last two decades of change in the make-up of
American corporate boards: the nominally independent CEOs and
former CEOs from outside companies who have come to dominate
corporate boards.
We address this weakness in the power thesis by arguing (1)
that nominally, independent directors on the compensation
committee disproportionately come from the ranks of current and
retired CEOs from other companies and (2) that these nominally
independent CEO and former CEO-directors have an interest to
promote, within the corporate sector, compensation policies
favorable to senior executives.
To examine the outside CEO-director community, we studied the
board make-up for the Business Roundtable's (BRT's) member firms
from 1987 to 2002.
JEL Classification: D23, G34, G38, J33, J38, J44, K22, M14
______________________________
"Back Door Links Between Directors and Executive Compensation"
BY: DAVID F. LARCKER
University of Pennsylvania
Accounting Department
SCOTT ANTHONY RICHARDSON
University of Pennsylvania
The Wharton School
ANDREW SEARY
Simon Fraser University
School of Communication
AYSE IREM TUNA
University of Pennsylvania
The Wharton School
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=671063
Date: February 2005
Contact: AYSE IREM TUNA
Email: Mailto:tunaai@wharton.upenn.edu
Postal: University of Pennsylvania
The Wharton School
3641 Locust Walk
Philadelphia, PA 19104-6365 UNITED STATES
Phone: 215-898-6769
Co-Auth: DAVID F. LARCKER
Email: Mailto:larcker@wharton.upenn.edu
Postal: University of Pennsylvania
Accounting Department
Philadelphia, PA 19104-6365 UNITED STATES
Co-Auth: SCOTT ANTHONY RICHARDSON
Email: Mailto:scottric@wharton.upenn.edu
Postal: University of Pennsylvania
The Wharton School
3641 Locust Walk
Philadelphia, PA 19104-6365 UNITED STATES
Co-Auth: ANDREW SEARY
Email: Mailto:seary@sfu.ca
Postal: Simon Fraser University
School of Communication
8888 University Drive
Burnaby, British Columbia V5A 1S6 CANADA
ABSTRACT:
This paper examines whether links between inside and outside
directors have an impact on CEO compensation. Using a
comprehensive sample of 22,074 directors for 3,114 firms, we
develop a measure of the "back door" distance between each pair
of directors on a company's board. Specifically, using the
entire network of directors and firms, we compute the minimum
number of other company boards that are required to establish a
connection between each pair of directors (ignoring the obvious
link that occurs when directors are on the same board). The back
door distance provides a measure for the existence and strength
of a communication channel between board members that can be
used to influence decisions by the board of directors. We
document that CEOs at firms where there is a relatively short
back door distance between inside and outside directors or
between the CEO and the members of the compensation committee
earn substantially higher levels of total compensation (after
controlling for standard economic determinants and other
personal characteristics of the CEO and the structure for board
of directors). This statistical association is consistent with
recent claims that the monitoring ability of the board is
hampered by "cozy" and possibly difficult to observe
relationships between directors.
JEL Classification: C40, M41, G34, J33
______________________________
"Executive Compensation at Fannie Mae: A Case Study of Perverse
Incentives, Nonperformance Pay, and Camouflage"
BY: LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley - School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=653125
Paper ID: Harvard Law and Economics Discussion Paper No. 505; UC
Berkeley Public Law Research Paper No. 653125
Date: February 2005
Contact: LUCIAN ARYE BEBCHUK
Email: Mailto:bebchuk@law.harvard.edu
Postal: Harvard Law School
1563 Massachusetts Avenue
Cambridge, MA 02138 UNITED STATES
Phone: 617-495-3138
Fax: 617-496-3119
Co-Auth: JESSE M. FRIED
Email: Mailto:FRIEDJ@MAIL.LAW.BERKELEY.EDU
Postal: University of California, Berkeley - School of Law
Boalt Hall
Berkeley, CA 94720-7200 UNITED STATES
ABSTRACT:
This paper examines Fannie Mae's executive compensation
arrangements during the period 2000-2004. We identify and
analyze four problems with these arrangements. First, by richly
rewarding executives for reporting higher earnings, without
requiring return of the compensation if earnings turned out to
be misstated, Fannie Mae's arrangements provided perverse
incentives to inflate earnings. Second, Fannie Mae's
arrangements provided soft landings to executives who were
pushed out by the board for failure; expectation of such outcome
adversely affected ex ante incentives. Third, even if the
executives had retired after years of unblemished service, the
value of their retirement packages would have been largely
unrelated to their own performance while in office, weakening
the link between pay and performance. Fourth, both when
promising retirement payments to executives and when making
these payments, Fannie Mae's disclosures obscured rather than
made transparent the total values of the executives' retirement
packages. Because many other companies have practices similar to
Fannie Mae's, our study highlights some general problems with
existing pay practices and the need for reform.
JEL Classification: D23, G32, G34, G38, J33, J44, K22, M14
______________________________
"Effects and Unintended Consequences of the Sarbanes-Oxley Act on
Corporate Boards"
BY: JAMES S. LINCK
University of Georgia
Department of Banking and Finance
JEFFRY M. NETTER
University of Georgia
Department of Banking and Finance
TIANXIA YANG
University of Georgia
Department of Banking and Finance
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=687496
Date: March 15, 2005
Contact: JEFFRY M. NETTER
Email: Mailto:jnetter@terry.uga.edu
Postal: University of Georgia
Department of Banking and Finance
Terry College of Business
Athens, GA 30602-6253 UNITED STATES
Phone: 706-542-3654
Co-Auth: JAMES S. LINCK
Email: Mailto:jlinck@terry.uga.edu
Postal: University of Georgia
Department of Banking and Finance
Terry College of Business
Athens, GA 30602-6253 UNITED STATES
Co-Auth: TIANXIA YANG
Email: Mailto:tyang@uga.edu
Postal: University of Georgia
Department of Banking and Finance
Terry College of Business
Athens, GA 30602-6253 UNITED STATES
ABSTRACT:
In response to the high-profile scandals like Enron and
WorldCom, President Bush signed the Sarbanes-Oxley Act (SOX)
into law on July 30, 2002. The Act represents the most sweeping
overhaul of the securities law since the Great Depression and
brings significant changes to corporate governance and boards of
directors. Using a sample of nearly 7,000 public firms, we study
the impact of SOX on corporate boards. We find that board
independence - characterized as the percentage of non-employee
directors (outsiders) on the board, the percentage of firms with
a majority of outsiders on the board, and the percentage of
firms with separate CEO and Chairman - increases significantly
after the passage of SOX. Firms increase board independence by
adding non-executive directors rather than removing executive
directors, resulting in larger boards. Further, board changes
are most significant for firms that are targeted by SOX and for
firms with large managerial ownership. In addition, director
turnover and replacement increases significantly after the
passage of SOX. Executive directors are less likely to be added
to the board in the post-SOX period than in the pre-SOX period,
while non-executive directors are more likely to receive the
nomination. Finally, we provide preliminary evidence of some of
the effects of Section 404, specifically increased numbers of
committees and committee meetings. There is also strong evidence
that SOX has imposed disproportionate burdens on small firms.
For example, small firms paid $5.91 to non-employee directors on
every $1,000 in sales in the pre-SOX period, which increased to
$9.76 on every $1000 in sales in the post-SOX period. In
contrast, large firms incurred 13 cents in director cash
compensation per $1,000 in sales in the Pre-SOX period, which
increased only to 15 cents in the Post-SOX period.
JEL Classification: D23, G32, G34, G38, K22, M14
______________________________
"Do Mutual Fund Managers Monitor Executive Compensation?"
BY: DAVID R. GALLAGHER
University of New South Wales
School of Banking and Finance
GAVIN SMITH
University of New South Wales - School of Banking
and Finance
PETER LAWRENCE SWAN
University of New South Wales
School of Banking and Finance
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=683786
Date: March 14, 2005
Contact: GAVIN SMITH
Email: Mailto:gavinsmith@student.unsw.edu.au
Postal: University of New South Wales - School of Banking and
Finance
Sydney, AUSTRALIA
Co-Auth: DAVID R. GALLAGHER
Email: Mailto:david.gallagher@unsw.edu.au
Postal: University of New South Wales
School of Banking and Finance
P.O. Box H58
Australia Square
Sydney NSW 2052, AUSTRALIA
Co-Auth: PETER LAWRENCE SWAN
Email: Mailto:peter.swan@unsw.edu.au
Postal: University of New South Wales
School of Banking and Finance
Sydney NSW 2052, AUSTRALIA
ABSTRACT:
We find significant relations between active mutual fund
portfolio holdings and executive compensation, which appear to
be largely driven by mutual fund investment styles rather than
monitoring behaviour. Aggressive growth fund holdings are
associated with performance pay, while income fund holdings are
negatively related. We also find that mutual fund holdings are
insensitive to changes in executive compensation and that growth
funds demand incentive pay that is in excess of optimal levels.
Our results suggest that one explanation for the lack of
observed monitoring is mutual funds fail to realise any
significant risk-adjusted excess returns from such behaviour.
JEL Classification: G23, G32, J33
______________________________
"Mutual Fund Proxy Votes"
BY: BURTON G. ROTHBERG
City University of New York - Stan Ross Department
of Accountancy
STEVEN B. LILIEN
City University of New York
Stan Ross Department of Accountancy
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=669161
Date: February 2005
Contact: BURTON G. ROTHBERG
Email: Mailto:burton_rothberg@baruch.cuny.edu
Postal: City University of New York - Stan Ross Department of
Accountancy
One Bernard Baruch Way, Box B12-225
New York, NY 10010 UNITED STATES
Co-Auth: STEVEN B. LILIEN
Email: Mailto:SLILIEN@BARUCH.CUNY.EDU
Postal: City University of New York
Stan Ross Department of Accountancy
One Bernard Baruch Way, Box B12-225
New York, NY 10010 UNITED STATES
ABSTRACT:
We examine how large mutual funds voted their proxies. Data
concerning fund voting has recently become available in two new
datasets. In the first, mutual funds are required to disclose
their policies for making voting decisions. In the second, they
are required to disclose how they actually vote on all issues.
We find that the large mutual fund families have decided to
vote the shares in all their funds as a block, thus increasing
their voting power. They claim they do not wish to interfere in
the operational management of their investments. This includes
social or ethical issues. However, they feel strongly about
antitakeover policies and executive compensation.
Analysis of the voting data shows that the largest funds voted
with management on most issues. However, they voted against
management often on antitakeover and executive compensation
issues. There is evidence that the funds voted against boards
that were not sufficiently independent from management.
We also find that voting patterns vary between funds with
different investment styles. Stock pickers tended to vote with
management more often. Funds with a passive investment approach,
such as index funds, tend to vote against management slightly
more often.
Finally, we investigate the question of conflicts of interest.
We compare the voting records of fund companies that are
primarily mutual funds to the voting records of fund companies
that are a small part of larger financial services companies. We
do not find a difference in how often they vote against
management.
JEL Classification: G30, K23
______________________________
"Executive Compensation at Fannie Mae and Freddie Mac"
BY: WILLIAM R. EMMONS
Federal Reserve Bank of St. Louis
GREGORY E. SIERRA
Federal Reserve Bank of St. Louis
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=678404
Paper ID: FRB of St. Louis Working Paper No. 2004-06
Date: October 26, 2004
Contact: WILLIAM R. EMMONS
Email: Mailto:EMMONS@STLS.FRB.ORG
Postal: Federal Reserve Bank of St. Louis
411 Locust St
St. Louis, MO 63011 UNITED STATES
Co-Auth: GREGORY E. SIERRA
Email: Mailto:Gregory.E.Sierra@stls.frb.org
Postal: Federal Reserve Bank of St. Louis
411 Locust St
St. Louis, MO 63011 UNITED STATES
ABSTRACT:
Corporate governance - and executive - compensation arrangements
in particular - should be an important component of the agenda
to reform the housing GSEs. The GSEs' safety-and-soundness
regulator - who is essentially the debtholders' and taxpayers'
representative - must be admitted to the GSEs' boardroom in a
way that is atypical of an ordinary publicly held company. This
intrusion into the board's oversight of executive-compensation
plans is justified given the GSEs' public purposes and their
large potential cost to taxpayers. Prudent public policy
requires greater supervisory control over executive compensation
at the GSEs, which would follow a precedent set in banking.