Executive Compensation When a Firm is a Business Group Member

Abstract

This paper examines how executive pay is set when a firm is a business group member. Using Korea as a laboratory setting, we find that member firm’s cash compensation for its executives is positively linked to the stock performance of other member firms as well as its own. Further analyses reveal that this positive link to other members’ performance is consistent with the hypothesis of corporate resources being tunneled from one member to another for the benefit of the controlling family. We find that this link is stronger to the performance of others that are more likely to benefit from tunneling (firms in which the controlling family has cash flow rights greater than those of the subject firm) and in firms that are more likely to suffer from tunneling (firms in which the controlling family has control-ownership disparity above the sample median).

Keywords: executive compensation, business groups, chaebols, tunneling, cash flow rights, control-ownership disparity, expropriation risk

JEL Classification: G30, G32, G34