The Determinants of CEO Compensation: Rent Extraction or Labour Demand?
34 Pages Posted: 19 Nov 2003
Date Written: January 2006
CEO compensation is topical and controversial and accordingly receiving considerable attention by various stakeholders. We investigate whether rent extraction or labour demand explains CEO compensation level in Australia. We do so by examining the determinants (economic, governance and ownership) of CEO compensation level and explore the relationship between predicted excess compensation and subsequent firm performance. Our results suggest that governance and ownership attributes, in addition to economic attributes, are significant determinants of CEO compensation. However, these attributes differentially determine the various components of CEO compensation. Our evidence is consistent with: a) the determination of fixed salary and share based compensation reflecting a firm's demand for a high quality CEO; and b) the CEO's ability to extract rent through bonus and options compensation, particularly for smaller firms or firms with above average performance. However, the rent extraction is not economically significant and does not persist beyond one year. This is in sharp contrast to the US evidence where rent extraction through CEO compensation is pervasive, economically significant and persistent (Core, Holthausen & Larcker, 1999).
Keywords: CEO compensation, Corporate Governance, Ownership structure, Firm performance
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