management

Topics: Chief executive officer, Corporate governance, Random effects model Pages: 28 (3597 words) Published: October 12, 2013
ISSN 1397-4831

WORKING PAPER 03-12

Tor Eriksson

The Managerial Power Impact on
Compensation
- Some Further Evidence

Department of Economics
Aarhus School of Business

THE MANAGERIAL POWER IMPACT ON COMPENSATION –
SOME FURTHER EVIDENCE*

Tor Eriksson
Aarhus School of Business, Department of Economics,
and Center for Corporate Performance

JEL Codes: M50, M52, J31
Keywords: Managerial power, Managerial compensation

* I am grateful to Dansk Management Forum for providing me the data used in the paper, to the Danish Social Science Research Council for financial support, and to Jingkun Li for useful research assistance. An earlier version of the paper was presented at the 2002 Academy of International Business Conference in Shanghai, in July 2002. Morten Bennedsen’s and Paul Bingley’s comments on an earlier version are much appreciated.

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1 Introduction
The principal idea of this paper is the following: there is some research, predominantly in the field of management research, suggesting that power (which has been defined in alternative ways) generates higher income to managers. However, the tests performed in many of the previous studies (see e.g., Finkelstein and Hambrick (1989), (1996), Lambert, Larcker and Weigelt (1993), Hambrick and Finkelstein (1995) and Barkema and Pennings (1988)) are not very strong. This is partly because they make use of potentially questionable measures of power, partly due to the study designs adopted. Three types of power measures have been used. The first is the manager’s own shareholdings, which is hypothesized to have an inverted U-shaped relation with the manager’s pay (Finkelstein and Hambrick (1989), (1996), Lambert, Larcker and Weigelt (1993)). A second measure is the chief executive’s ability to appoint outsiders on the board (Wade, O’Reilly and Chandradat (1990), Lambert, Larcker and Weigelt (1993), Core, Holthausen and Larcker (1999), Hallock (1997)) as proxied by the insiders’ share of board members or by CEO duality (the CEO serves as chair of the board of directors). Finally, a third measure used is the number of employees supervised by the manager (Schmidt and Fowler (1990), Lambert, Larcker and Weigelt (1993), Boyd (1994)).

The power measure is typically entered as a right hand side variable into a cross-sectional compensation equation with rather few controls, none of which (except for Frey and Kucher’s (1999) analysis) are individual characteristics. And yet, you would expect that human capital measures like experience, tenure and education would constitute important explanatory variables in a more complete analysis of managerial pay.1 It is, moreover, most likely that these same individual characteristics are instrumental in explaining differences in the amount of power the managerial employee possesses. Consequently, an interesting question is whether the results according to which there is a positive relationship between power and individual earnings still holds if we also cater for human capital. Some of the factors conducive for managerial power are probably unobserved (to the econometrician), but can be conceived of as individual fixed effects. Hence, a longitudinal analysis accounting for time-invariant unobservables, is called for. 1

As a matter of fact, most investigations of CEO or other top managers’ pay do not typically control for individual characteristics, save CEO tenure, which is included in some of the studies. The main reason is simply that they are lacking from the data sources used; for a survey of the literature, see Murphy (1999).

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As pointed out by Frey and Kucher (1999), there is an additional reason for why introducing human capital is potentially significant. An alternative hypothesis to the managerial power explanation is that there should be no relationship. This is because one can conceive of both monetary income and power as goods, and accordingly, both are arguments in the manager’s utility function....

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