Peer Group Choice and Chief Executive Officer Compensation
60 Pages Posted: 13 Feb 2019 Last revised: 29 Sep 2020
Date Written: August 22, 2019
We examine the selection of peer groups that boards of directors use when setting the level of CEO compensation. This choice is controversial because it is difficult to ascertain whether peer groups are selected to (i) attract and retain top executive talent or (ii) enable rent extraction by inappropriately increasing CEO compensation. In contrast to prior research, our analysis utilizes the degree to which the observed compensation level for the portfolio of peers is unusual relative to all potential portfolios of peers the board of directors could have reasonably selected. Using a sample of 9,247 firm-year observations from 2008 to 2014, we estimate that roughly 39% of board of directors’ choices appear to be associated with rent extraction, whereas the remaining 61% appear to be associated with attracting and retaining high-quality CEO talent. Relative to firms that appear to select peers for aspirational labor market reasons, we find rent extraction firms have more structural governance concerns and negative realized governance outcomes. Over our sample period, we estimate the aggregate excess pay for rent extraction firms is approximately $8.6 billion, or approximately 30% of their total reported compensation.
Keywords: CEO Compensation; Peer Groups; Agency Problems; CEO Labor Market
JEL Classification: M12; M52; G30; J33
Suggested Citation: Suggested Citation