An Empirical Examination of the Role of the CEO and the Compensation Committee in Structuring Executive Pay

Abstract

Motivated by the potential for opportunistic behavior in pay decisions, recent SEC and IRS regulations essentially preclude inside directors from serving on a firm's compensation committee. In this paper, we examine whether greater compensation committee independence promotes shareholder interests and, in particular, whether the CEOs presence on the compensation committee leads to opportunistic pay structure. We find some evidence that the greater outsider representation on the committee the higher levels of pay and the greater the sensitivity of pay to performance. Any differences we find in committee structure and committee controlled pay, however, are offset by differences in ownership. When considering both pay and ownership, we find no relationship between committee structure and total incentives. Interestingly, for CEOs who are members of the compensation committee, we find that they are modestly paid (in terms of salary and option pay) and own a lot of equity. When considering both incentive pay and ownership, the sensitivity of total wealth to firm performance is greater for CEOs who sit on the compensation committee. Finally, we do not find any evidence that CEO pay decreases or that total incentives increase when CEOs come off the compensation committee. Our results suggest that regulations governing committee structure may not reduce levels of pay or achieve efficiencies in incentive contracts.

JEL Classification: G30, G32, G38, K20