Peer Group Choice and Chief Executive Officer Compensation

61 Pages Posted: 13 Feb 2019

See all articles by David F. Larcker

David F. Larcker

Stanford University - Graduate School of Business

Charles McClure

University of Chicago Booth School of Business

Christina Zhu

University of Pennsylvania - The Wharton School

Date Written: February 11, 2019

Abstract

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 of peers in the portfolio is unusual relative to all potential portfolios of peers the board of directors could have reasonably selected. Using a sample of 10,235 firm-year observations from 2008 to 2014, we estimate roughly 33% of board of directors’ choices appear to be associated with rent extraction, whereas the remaining 67% are 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 realized negative governance outcomes. Over our sample period, we estimate the aggregate excess pay for rent extraction firms is approximately $5.4 billion, or 38% of their total pay.

Keywords: CEO Compensation; Peer Groups; Agency Problems; CEO Labor Market

JEL Classification: M12, M52, G30, J33

Suggested Citation

Larcker, David F. and McClure, Charles and Zhu, Christina, Peer Group Choice and Chief Executive Officer Compensation (February 11, 2019). Rock Center for Corporate Governance at Stanford University Working Paper No. 240; Stanford University Graduate School of Business Research Paper No. 19-15. Available at SSRN: https://ssrn.com/abstract=3333874 or http://dx.doi.org/10.2139/ssrn.3333874

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Charles McClure

University of Chicago Booth School of Business ( email )

7737024885 (Phone)

Christina Zhu

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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