Why Do Firms Use Compensation Peer Benchmarking?

55 Pages Posted: 1 May 2020

See all articles by Jin Xu

Jin Xu

Virginia Tech - Pamplin College of Business

Pengfei Ye

Virginia Polytechnic Institute & State University

Date Written: March 15, 2020

Abstract

We develop a cost-benefit tradeoff model to explain corporate boards’ decision whether to use compensation peer benchmarking. Peer benchmarking helps a board retain a talented but risk-averse CEO, but it weakens CEO incentives to exert effort. Consistent with high retention needs, benchmarking firms have more peer citations, operate in general business domains with more similar firms, and their CEOs are at the most marketable age. Benchmarking firms also tend to be younger and have more volatile stock returns and earnings and higher leverage, where CEO performance is riskier. Consistent with high incentive costs, CEO pay-performance sensitivities are lower and CEO pay growth is higher at benchmarking firms. To mitigate such costs, benchmarking firms award their CEOs more equity annually and are more likely to dismiss them for poor performance. When retention needs are low, peer benchmarking is associated with lower firm value. Retention needs can also explain peer selection decisions.

Keywords: Compensation Peer Benchmarking, CEO Labor Market, Pay-Performance Sensitivity, Forced CEO Turnover, Firm Value, Peer Pay Effect

JEL Classification: D86, G34, J3, M12

Suggested Citation

Xu, Jin and Ye, Pengfei, Why Do Firms Use Compensation Peer Benchmarking? (March 15, 2020). Available at SSRN: https://ssrn.com/abstract=3569930 or http://dx.doi.org/10.2139/ssrn.3569930

Jin Xu (Contact Author)

Virginia Tech - Pamplin College of Business ( email )

Department of Finance
880 West Campus Dr
Blacksburg, VA 24061
United States

HOME PAGE: http://finance.pamplin.vt.edu/directory/xu.html

Pengfei Ye

Virginia Polytechnic Institute & State University ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

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