Assessing Key Determinants Of CEO Compensation

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Very few business topics are as widely contested as CEOs compensation. The amount that CEOs are paid and the structure of their pay is frequently debated in many research works and therefore these research works have been diversified due to different perceptions of different economists. Miller (1995 pp.1361) quotes "studies investigating the relationship between executive compensation and firm's performance firm's size or both have had consistently low explanatory power." Whereas Roberts (1956) believes that there is high level of significance between CEO compensation and corporate size. At the same time he also comments on the relationship between profits of a firm and compensation, and claims it to be superficial. He deduces that the impact of profits on compensation vanishes and becomes statistically insignificant when impact of size is considered on compensation and profits.

With changing market demand, diversity in work place and new growth opportunities for CEOs, their ability to stay in the dynamic environment and the level of salary they receive has gained immense interest in both business and economic concerns. Also with the recent recession, sales and profit of a firm have become even more significant variables in determining CEO compensation. Therefore this research would focus on analysing in depth about the various factors which are involved and play a significant role in affecting CEO compensation. It will explore relationship between individual aim, incentive and compensation in relation to CEOs compensation.

Relevant Theories

Understanding what affects CEOs compensation is focus of many researchers, like Burress and Zucca (2004 pp.55) Quotes "The wages for women compared to men in general have been increasing over time. However... the gender earnings gap persists." Their study also reveals that wage differences are mainly for hourly employees rather that executives and that difference in compensation occurs due to segregation in industries and not because of employee discrimination.

McKnight, et al (2000) suggested that correlation between CEOs salary and age was found to be significant but weakening overtime. They discussed that as the age of the CEO increases, his scholar capabilities increase due to the awareness, knowledge and experience he has gained. And further they argue that as the CEO becomes wealthier, and grows in age he has a diminishing utility of income and also prefers less risk, thus this change leads to change in his expectations also and in turn his requirement for cash would decrease.

Hill and Phan (1991) propose that tenure strongly points out at the relationship between CEO pay and firm size. His research concludes the relation to be positive and claims that as the tenure increases the relationship gets stronger. He also determines the relationship between stock returns and pay of CEO to be positive but it weakens as the tenure increases.

McGuire, Chiu and Elbing (1962) found CEOs compensation to be closely related to sales of the firm and less related to profits. This tells us that with increase in sales CEOs salary increases more as compared to with increase in profits, so they will focus on maximising sales rather than profits. They also point out that while determining CEOs compensation, past sales also play an important role, as the compensation reward is mainly an incentive for the past sales and does not act as an incentive for future sales. Differing from this Lewellen and Huntsman (1970) showed a positive relation between compensation and profits instead of sales.

Hijazi and Bhatti (2007) established that firm's size is closely related to employer's ability to pay in determining CEO salary. According to them, CEO compensation plays a major role in reward strategy and crucial role in the growth and profits of the firm, if the firm gives correct incentives to the CEO then they are able to keep hold of the right people and optimise their employee cost.

Research Questions

How significant are the financial variables like profits, sales and assets of a firm in determining the pay of a chief executive officer?

How significant are the non-financial variables like age, tenure, gender of a CEO in determining his/her salary?

Methodology

This research will effectively make use of the models and the theories in this field to study the important factors responsible for affecting CEOs compensation.

Econometric Model

The model used for this research is as follows:

CEOC = + Tenure +Age + Sales + Profits + Assets + Gender + u

Dependent variable:

CEO compensation (CEOC) = salary + bonus + Stock gains + other gains

Independent variables:

Tenure = no. of years as CEO

Age = age of CEO

Sales = total 2009 sales revenue of firms

Profits = 2009 profits of firms

Assets = total assets of firms in 2009

Gender = gender of CEO (=0 if male, =1 if female)

The above model has been referred from Department of economics, SUNY- Oswego by John Kane (www.oswego.edu/~kane/econometrics/ceo.htm). This research will incorporate an extra variable, gender, which is a dummy variable, because it is believed that there is gender equity gap still existing at executive positions.

Data

Data has been collected from two principal sources, Forbes and Fortune 500 which will be analysed through cross sectional regression analysis. For drawing inferences, hypothesis testing will be used. The sample consists of 500 firms selected on the following criteria: the firms will be of US origin and must be listed. The period of investigation will be 2009. The data on total compensation, tenure, age and gender will be collected from Forbes and data on sales, profits and assets will be collected from Fortune500 for the same firms.

Prediction of results

Having examined the impact of these variables on CEOs compensation from the relevant literature, it is expected that a positive relation will be shown for tenure and age on compensation, which might decrease over time. The CEOs compensation will positively depend on sale, profits and assets. As these increase for the firm, they will be paying more to the CEO. In generals male CEO will be expected to have a higher compensation than women CEO.

Limitations

As with any research there are limitations to be expected, one of them being that some firms will not be included due to absence of data on one or more variables. Like most studies related to compensation, my research also considers convenience sample, the data is not representing all business firms but only the top 500 firms of U.S.A. Also different firms might take into consideration different measures to assess the CEOs performance but this diversity is not considered while performing the analysis. The research assumes that CEO of a firm can affect the performance of the firm and bring about changes, but this might not be the case always.

References

Burress Joanne Healy and Zucca Linda J. (2004). The Gender Equity Gap in Top Corporate Executive Positions. Mid-American Journal of Business. 19 (1), 55-62.

Forbes. (2009). CEO COMPENSATION. [Online] Available: www.forbes.com/lists/2009/12/best-boss-09_CEO-Compensation_Rank.html. [Accessed 24 June 2010].

Fortune500.(2009). CEOs. [Online]Available:http://money.cnn.com/magazines/fortune/fortune500/2009/ceos/. [Accessed 24 June 2010].

Hijazi Syed Tahir and Bhatti Komal Khalid. (2007). Determinants of Executive Compensation and Its Impact on Organizational Performance. Compensation and Benefits Review. 39 (2), 58-68.

Hill Charles W.L. and Phan Phillip. (1991). CEO Tenure as a Determinant of CEO Pay. Academy of Management Journal. 34 (3), 707-717.

Kane John. (2009). CEO Salary, Sales and Profits Data. [Online] Available: www.oswego.edu/~kane/econometrics/ceo.htm. [Accessed 24 June 2010].

Wilbur G and Huntsman Blaine. (1970). Managerial Pay and Corporate Performance. The American Economic Review. 60 (4), 710-720.

McGuire Joseph W, Chiu John S. Y and Elbing Alvar O. (1962). Executive Incomes, Sales and Profits. The American Economic Review. 52 (4), 753-761.

McKnight Phillip J, Tomkins Cyril, Weir Charlie and Hobson David. (2000). CEO Age and Top Executive Pay: A UK Empirical Study. Journal of Management and Governance. 4 (3), 173-187.

Miller Daniel J. (1995). CEO Salary Increases May Be Rational after All: Referents and Contracts in CEO Pay. The Academy of Management Journal. 38 (5), 1361-1385.

Roberts David R. (1956). A General Theory of Executive Compensation Based on Statistically Tested Propositions. Quarterly Journal of Economics. 70 (2), 270-294.

Shah Syed Zulfiqar Ali, Javed Tariq and Abbas Muhammad. (2009). Determinants of CEO Compensation: Empirical Evidence from Pakistani Listed Companies. International Research Journal of Finance and Economics. Iss. 32, Eurojounals Publishing, Inc.

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