Illusory Correlation in the Remuneration of Chief Executive Officers: It Pays to Play Golf, and Well
42 Pages Posted: 7 Apr 2009 Last revised: 15 Mar 2011
Date Written: July 31, 2010
Setting CEO compensation is a critical but difficult task. Thus, given the lack of transparency that frequently accompanies such decisions, it is important to know whether it is subject to bias. We document the presence of illusory correlation in CEO compensation. By this we mean the use of information in the decision making process that is either irrelevant or, worse, inversely related to shareholders' value maximization, which is the criterion of interest. We use publicly available data from the USA for the years 1998, 2000, 2002, 2004 and 2006 to examine the relations between golf handicaps of CEOs and corporate performance, on the one hand, and CEO compensation and golf handicaps, on the other hand. We find a strong relation between handicap and CEO compensation -- golfers earn more than non-golfers and pay increases with golfing ability. We also find a relation between handicap and corporate performance -- golfers perform worse than non-golfers and performance decreases with golfing ability. Furthermore, when low-ability golfers are appointed as CEOs, there are positive stock price reactions. These findings emphasize the difficulties of tasks such as judging compensation for CEOs. To overcome this -- and possibly other illusory correlations -- we recommend the use of explicit, mechanical decision rules to ensure a transparent process.
Keywords: Illusory correlation, executive compensation, golf handicaps, decision rules, LeeX
JEL Classification: D03, D81, J33
Suggested Citation: Suggested Citation