Journal of Financial Economics 100 (2011) 538–555
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Journal of Financial Economics
journal homepage: www.elsevier.com/locate/jfec
Are all CEOs above average? An empirical analysis of compensation peer groups and pay design$ John Bizjak a,n, Michael Lemmon b,c, Thanh Nguyen d
Texas Christian University, Neeley School of Business, TCU, PO Box 298530, Fort Worth, TX 76129, United States University of Utah, United States Hong Kong University of Science and Technology, Hong Kong d California State University, Fullerton, United States b c
a r t i c l e in f o
Article history: Received 8 April 2009 Received in revised form 19 July 2010 Accepted 27 July 2010 Available online 15 February 2011 JEL classiﬁcation: G34 J31 J33 Keywords: Executive compensation Benchmarking Peer groups CEO pay
Companies can potentially use compensation peer groups to inﬂate pay by choosing peers that are larger, choosing a high target pay percentile, or choosing peer ﬁrms with high pay. Although peers are largely selected based on characteristics that reﬂect the labor market for managerial talent, we ﬁnd that peer groups are constructed in a manner that biases compensation upward, particularly in ﬁrms outside the Standard & Poor’s (S&P) 500. Pay increases close only about one-third of the gap between the pay of the Chief Executive Ofﬁcer (CEO) and the peer group, however, suggesting that boards exercise discretion in adjusting compensation. Preliminary evidence suggests that increased disclosure has reduced the biases in peer group choice. & 2011 Elsevier B.V. All rights reserved.
companies that corporations measure themselves against when calculating compensation.1
When shareholders question lush pay, they are invariably met with a laundry list of reasons that businesses use to justify such packages. Among that data, no item is more crucial than the ‘‘peer group,’’ a collection of
$ We are grateful to Kevin Murphy, the referee, for comments that substantially improved the paper along with AFA discussant Jun Yang, and participants at Arizona State University, Indiana University South Bend, the University of British Columbia, the University of Utah, the 2009 FMA Doctoral Consortium and the 2010 meetings of the American Finance Association. Part of this project was done while Thanh Nguyen was at the University of Utah and he would like to acknowledge them for providing ﬁnancial support. n Corresponding author. Tel.: + 1 817 257 4260. E-mail address: firstname.lastname@example.org (J. Bizjak).
Arguably few economic topics stir as much passion, controversy, and debate as CEO pay. As the above quote illustrates, for many ﬁrms one of the driving factors in setting both levels of pay and pay structure is the use of compensation peer groups. One of the biggest concerns with this practice, however, is that peer groups can be used to inﬂate pay levels. For example, according to RiskMetrics, the compensation peer group used in 2007 by the hairstyling company Regis Corp., which owns Vidal Sassoon and Supercuts, included Starbucks and H&R Block—ﬁrms that are much larger, in different industries,
1 ‘‘Peer pressure: Inﬂating executive pay,’’ by Gretchen Morgenson, New York Times, November 26, 2006 (Morgenson, 2006).
0304-405X/$ - see front matter & 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.jﬁneco.2011.02.007
J. Bizjak et al. / Journal of Financial Economics 100 (2011) 538–555
and with signiﬁcantly higher CEO pay than Regis.2 In general, critics of the use of peer group benchmarking argue that powerful CEOs and co-opted boards opportunistically choose peer ﬁrms in a way that inﬂates CEO pay (e.g., Bebchuk and Fried, 2004). Moreover, the critics also contend that, given the prevalence of benchmarking, the opportunistic choice of peer ﬁrms has led to an upward ratcheting of pay levels over time. Alternatively, the use of competitive benchmarking can...
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