Peer Group Ties and Executive Compensation Networks

Abstract

Publicly traded firms in the U.S. typically determine C.E.O. compensation by benchmarking the pay of their C.E.O.s against the pay of C.E.O.s in “peer” firms. The naming of particular peer companies by individual firms constitutes a supra-firm relational structure (network) in which an individual firm’s executive pay setting is embedded. As such, the compensation structure and level for any one executive at any one firm is influenced not only by firm-level characteristics, but also by the selection and actions of the firm’s immediate peers, and by the structure of the executive compensation network overall. Analyzing 56,718 C.E.O. compensation peer group choices made by the same 1,183 firms for fiscal years 2007, 2008 and 2009, we find that while the typical compensation peer is similar in size and industry to the firm that chose it, deviations from this norm are common, especially among larger firms. When firms go outside their normative size/industry peer population, their choice is structured: they tend to choose peers larger and better paid than themselves. Simulations suggest that the bias is statistically significant in all three years, and in the 26-37% range, depending upon the particular benchmark location at which the bias is measured. Further analysis shows that firms who pay CEOs nearer the top of their natural benchmark distribution, and who pay their firms well relative to the pay that would be predicted from their revenues, return on assets, and industry tend to have greater aspiration bias in their group of named peers, which arguably is done to provide justification for the relatively high rate of compensation.