Does Independent Advice to The Board Affect CEO Compensation?

Abstract

This paper investigates the role external advice plays in the board’s determination of CEO compensation. We show that CEO incentive pay increases with the degree of compensation consultant independence using a quasi-natural experiment provided by the creation of an independent consultant after separation from an affiliated consultant. Specifically, switching to an independent consultant significantly increases Pay-Performance Sensitivity and Relative Performance Evaluation of CEO contracts. Despite the benefits of independent advice, independent consultants may not be hired due to the influence of powerful CEOs or because boards already possess adequate expertise.

Keywords: Compensation Consultants, Independent Advice, Pay-Performance Sensitivity

JEL Classification: G30, G34, J33, J41