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CEO Utility Pay Literature Review

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  • CEO Utility Pay

Utility CEO Pay

From Wikipedia: Electric Utility "The compensation received by the executive in utility companies often receives the most scrutiny in the review of operating expenses. Just as regulated utilities and their governing bodies struggle to maintain a balance between keeping consumer costs reasonable and being profitable enough to attract investors, they must also compete with private companies for talented executives and then be able to retain those executives."

see Executive Compensation in the U.S. for a summary on why private companies seem to have an advantage in terms of CEO pay.

Why CEO Utility Pay?

CEO, or Chief Executive Officer, salary has risen dramatically over the past two decades. Utility companies are found to pay their CEO's significantly less than their private counterparts. This is being investigated to determine the chief reasons CEO's in the electrical utility industry seem to be paid less, and discover if their pay is justified.

Factors of CEO Pay

There are several generally agreed upon components to a CEO's salary:

  • Base Salary
  • Incentive Pay, Short Term (i.e., bonus)
  • Incentive Pay, Long Term (i.e., stocks)
  • Benefits (i.e., Cars, Health Care, Retirement)

Running Notes and Ideas

This is a collection of ideas I develop while conducting the literature review. Comments and edits, as well as new ideas are appreciated here.

  • Gather data on many firms from both electric utilities and non-regulated industries.
  • Use this data (firm size, stock price, etc.) in minitab to discover what variable are more significant in calculating the pay of a CEO for both industries.
  • use minitab to see if utility idustries pay more with salary/bonus or stock options than non-regulated firms.
  • Research how compensation contracts are designed

Literature Review of CEO Utility Pay

Electric Utility Compensation

Executive Compensation and Corporate Performance in Electric and Gas Utilities

A. Agrawal, A. K. Makhija, and G. N. Mandelker, “Executive Compensation and Corporate Performance in Electric and Gas Utilities,” Financial Management, vol. 20, no. 4, p. 113, Winter 1991.

  • Measurement of profitability:
  1. accounting data
  2. stock market returns
  • Managers should be rewarded for ability, responsibility, firm size, past performace, current performance
  • Need to focus on whole compensation package (bonus, stocks, salary, etc.)
  • Most studies look at historical data. How do I predict future data?
  • 2 views on what CEOs strive for:
  1. maximize sales in order to grow their own job security, perks, prestige, and control
  2. market forces and compensation contract align the CEO with stockholder interests. i.e., maximize stockholder wealth
  • Used all utility firms with the SIC codes 4911 and 4931 on the COMPUSTAT tapes which were listed on the New York Stock Exchange or the American Stock Exchange in 1985
  • Proxy statements were requested directly from these firms for the period of 1975-1984.
  • size was measured by: sales, number of employees, shares outstanding, market value of equity, or total book value of assets
  • Consumer Price Index was used to convert dollar values across time
  • Stock options were ignored because they were so rarely used in compensation
  • pension benefits were ignored because of the difficulty of estimating their value and contribution
  • Demand for the public utility's product is mostly determined by economic and weather conditions in the area.
  • public utility's price is set by the public utility commission
  • Concluded that compensation for managers shifted their goals to line up with the stockholders'
  • This contradicts the most common view, that utility managers do not have incentive to increase stockholders wealth

Executive Compensation Contract Adoption in the Electric Utility Industry

W. N. Lanen and D. F. Larcker, “Executive Compensation Contract Adoption in the Electric Utility Industry,” Journal of Accounting Research, vol. 30, no. 1, pp. 70–93, 1992.

  • Hypothesis: Changes in executive compensation contracts are an organizational response to shifts in the firm's external environment and/or corporate strategy
  • Results provide "modest" evidence that the adoption of compensation contracts into pay structure of electric utilities is related to changes in incentive regulation and production efficiency
  • No relation between adoption of new contracts and firm diversification
  • no relation between cash compensation (salary+bonus) and electric performance and production efficiency.
  • Utilities that see increases in incentive regulation and with low production efficiency will adopt compensation contracts
  • results have only modest level of statistical significance
  • see note one for more sources on the history of the industry
  • 2 regulatory types:
  • passes the cost of inefficiency to customer (i.e., sets prices at above what the firm's costs are currently)
  • makes shareholder wealth a direct function of inefficiency (i.e., promotes innovation and efficiency)

Political Constraints on Executive Compensation: Evidence from the Electric Utility Industry

P. L. Joskow, N. L. Rose, and C. D. Wolfram, “Political Constraints on Executive Compensation: Evidence from the Electric Utility Industry,” The RAND Journal of Economics, vol. 27, no. 1, pp. 165–182, 1996.

  • covers 1978-1990
  • 2 extreme views help highlight the array of views on the topic:
  1. CEO compensation is not sensitive enough to firm financial performance
  2. executive compensation is generally controlled by the CEO rather than the board of directors, giving CEOs a higher salary
  • 2 ways political constraints can affect pay:
  1. It can make a CEO's job easier, making it more profitable to reduce the CEOs pa, tie pay less to firm performance, etc.
  2. The board may react to the high CEO pay currently observed and try to reduce the costs.
  • Salomon Brothers regulatory environment rankings were used.


  • CEO Compensation:
  • annual salary and bonus (Forbes' annual survey of CEO compensation and proxy statements)
  • salary and bonus captures almost all of a CEOs pay in the industry (95%)
  • CEO characteristics(Forbes' survey or proxy statements):
  1. age
  2. tenure in office
  3. if the CEO was hired from outside the company or promoted
  • Firms Characteristics:
  1. Firm size(revenue, assets, employees used to measure from COMPUSTAT Utility Tapes)
  2. Financial performance(COMPUSTAT Tapes, stock market rates of return)
  3. measures of organizational structure(utility annual reports, 10k filings, financial analysts' reports. if it is organized as an exempt holding company and if it has diversification into non regulated industries.)
  • Regulatory and Political Environment:
  1. Salomon Brothers' Rankings
  2. residential and industrial rate change
  3. characteristics of each states regulatory agency(annual issues of the National Association of Regulatory Utility Commissioners' annual report on utility and carrier regulation, 1978-1990.
  • CEO compensation results:
  • paid less when their firms regulatory environment favors consumers
  • Paid less when rates are high or rising rapidly (mostly residential)
  • paid less when their state has an elected commissioner

Ownership, Regulation, and Managerial Monitoring in the Electric Utility Industry

R. R. Geddes, “Ownership, Regulation, and Managerial Monitoring in the Electric Utility Industry,” The Journal of Law & Economics, vol. 40, no. 1, pp. 261–287, 1997.

  • addresses/examines 3 issues:
  • sensitivity of manager turnover in investor owned utilities to changes in owner and customer wealth
  • government owned firms are included in the investigation of turnover & performance vs. manager turnover
  • estimates of manager turnover from The Journal of Political Economy were replicated
  • Under regulation, if a firm is marking at least the allowed rate of return, the CEO doesn't have to care about owner's interests, and inefficiency has no costs.
  • Data retrieved from: Statistics of Publicly Owned Electric Utilities in the United States and Statistics of privately Owned Electric Utilities in the United States over the years 1966-1988
  • turnover in all firms does not change with shareholder wealth (accounting terms)
  • turnover in investor-owned was insensitive to changes from the allowed rate of return and real allowed return
  • Turnover is related to changes in consumer welfare (prices)
  • Turnover is similar across all firms
  • turnover in government owned utilities is more sensitive to firm size than investor owned.
  • Appendix A, Table A1 lists all data sources

Strategic orientations, incentive plan adoptions, and firm performance: Evidence from electric utility firms

N. Rajagopalan, “Strategic orientations, incentive plan adoptions, and firm performance: Evidence from electric utility firms,” Strategic Management Journal, vol. 18, no. 10, p. 761, 1997.

  • Relates everything to Miles and Snow (1978) Defender and Prospector firms
  • Not very useful, re-states what other studies have said, but makes it more confusing by adding defender vs. prospector firms.
  • Prospector Firms: Offer their top managers discretion.
  • Defender firms: Adopt and protect narrow and stable domains.
  • Hypothesis 1: Annual bonus plans will have a stronger positive effect on firm performance among defenders than among prospectors
  • supported for accounting measure of performance, not market measure
  • Hypothesis 2a: Long term performance plans which use accounting measures as performance criterea will have a stringer positive effect on firm performance among defenders than among prospectors
  • Not supported
  • Hypothesis 2b: Long term plans which use market-based measures as performance criterea will have a stronger positive effect on firm performance among prospectors than among defenders
  • Strong support
  • Hypothesis 2c: long term performace plans which offer cash incentives will have a stronger positive effect on firm performance among defenders than among prospectors
  • Not supported`
  • Hypothesis 2d: long term performance plans which offer stock incentive will have a stronger positive effect on firm performance among prospectors than among defenders
  • Strong support
  • Hypothesis 3: Stock option plans will have a stronger positive effect on firm performance among prospectors than among defenders
  • Strong support

Linking CEO pay to firm performance: empirical evidence from the electric utility industry

Augustine I. Duru and Raghavan J. Iyengar, “Linking CEO pay to firm performance: empirical evidence from the electric utility industry,” Managerial Finance, vol. 25, no. 9, pp. 21–33, Sep. 1999.

  • Suggests CEO pay is structured in a way that rewards CEOs who can increase the utility rate to consumers.
  • In unregulated industry, traditional CEO skills could be required.
  • In electric utility, traditional skills might not be needed.(regulation can make these skills obsolete)
  • This paper trys to solve the disagreement on the relationship between firm performace and CEO compensation.
  • It uses Canonical correlation analysis (CCA). this helps to relate many variables at once.
  • increase in firm performance leads to increase in compensation
  • Increase in market returns leads to increase in bonus
  • Increase in sales growth(increase in rate to consumers) leads to increase in stock options
  • Compensation Components include:
  • Salary
  • Bonus
  • Long-term compensation
  • stock options
  • Performance Measures include:
  • Market returns
  • Return on assets
  • earnings per share
  • Operating cash flow per share
  • Growth in sales
  • In order to not need to know things like executive age, tenure, experience, ability, etc. changes in compensation were measured.
  • final results show that firm performance increase has "moderate predictive power" for compensation
  • Increase in market returns gives increase in short term compensation
  • market returns are a good way to measure firm performance
  • Did not separate the stages of production or the ownership of the firm in this study. This is important if calculation of the exact salary is needed.
  • This also only did a linear relationship between variables. It could fit better if a higher order was used.
  • almost 45% of the sample used included stock options. other studies have stated that stock is a minor part of the total compensation but here that appears false.

The impact of regulation on CEO labor markets

D. Palia, “The impact of regulation on CEO labor markets,” RAND Journal of Economics, vol. 31, no. 1, p. 165, 2000.

  • Utilities attract CEOs with a lower quality education than unregulated industries do
  • Used educational background to measure manager quality. This isn't very good but it is the only reliable way
  • Mentions the utility industry is expecting deregulation
  • Utilities have more engineers and lawyers than MBAs.
  • after deregulation in the airline industry, the quality of CEOs went up and the number of CEOs with MBAs went up
  • Measured performance of firms with stock returns, not accounting numbers
  • Calculated value of stock options with Black and Scholes option validation model, assuming continuously paid dividends.
  • Most executive options have a ten-year maturity
  • random control group of manufacturing firms (SIC codes 2000-3999 from Standard and Poor's compustat)
  • schooling, tenure w/ firm, tenure w/ CEO, previous jobs, etc. are all found in MArquis's Who's Who in finance and industry, Dun and Bradstreet's Reference book of corporate managements, and the standard and poor's registar of corporations, directors, and executives.
  • all CEO compensation variables are obtained from the annual proxy statements filed by firms with the SEC.
  • Tobin Q values were calculated
  • Utilities tend to have larger capital expenditures
  • Utilities also have lower research and development expenses.
  • Utilities have a lower pay-performance sensitivity than unregulated firms.
  • This is mostly driven by options and share holdings
  • The paper describes specific numerical values of unregulated industries vs. regulated industries
  • Possible reasons CEO quality is lower during regulation:
  • returns to CEO quality are lower during regulation
  • The compensation of CEOs during regulation is restricted, so better CEOs go elsewhere

CEO Compensation after Deregulation: The Case of Electric Utilities

S. Bryan, L. Hwang, and S. Lilien, “CEO Compensation after Deregulation: The Case of Electric Utilities,” The Journal of Business, vol. 78, no. 5, pp. 1709–1752, 2005.

  • In 1992 NEPA decreased regulation. This affected the CEO compensation by increasing firm competition
  • Assumes that managers behave in a way consistent with their compensation
  • FERC's Form 1 gives information on firms performance, and could be useful
  • A control sample of other non-regulated firms was used
  • CEO compensation becomes more performance based after regulation ended.
  • Firms have annual SEC proxy statements that summarize their CEO-compensation policies
  • deregulation requires more time from the CEO, which increases CEO compensation
  • Stock option compensation Variables include:
  1. Investment opportunity set (IOS)
  2. Agency cost of debt
  3. Liquidity Constraints
  4. Firm Size
  • SIC codes 4911 and 4931 has firms with data used in samples
  • Components of compensation
  1. Salary
  2. Annual cash bonus
  3. value of stock options
  4. value of restricted stock grants
  5. long-term incentive plan payments
  • Value of stocks was measured using Black-Scholes (1973) model.
  • data was received from the Compustat and the Center for Research in Security Prices (CRSP) databases.
  • Ways to estimate the relation between CEO compensation and earnings performance:
  1. firm specefic regressions
  2. Regression for pooled data set
  • Variables used in calculations:
  1. sample period
  2. Free cash flow
  3. long term debt
  4. investment opportunity set
  5. total assets (natural log)
  6. CEO stock ownership
  7. regulatory environment indicator
  8. earnings based measures of performance (2 total)
  9. variance of annual earnings
  10. variance of monthly stock returns
  • Variables used in calculations of CEO pay:
  1. salary
  2. Bonus
  3. stock option (black-scholes pricing)
  4. restricted stock compensation
  5. long term incentive plan layout
  6. ratio of CEO stock option compensation to cash compensation(salary+bonus)
  • benefits was purposefully left out.
  • This paper did not specify if firms were coal, solar, hydro, etc. This would help.
  • The paper gives a future research topic into the reasoning of why there is a reweighting of the parameters of bonus formulas that certain utilities undertook during worse performance.

Deregulation and environmental differentiation in the electric utility industry

M. Delmas, M. V. Russo, and M. J. Montes-Sancho, “Deregulation and environmental differentiation in the electric utility industry,” Strat. Mgmt. J., vol. 28, no. 2, pp. 189–209, Feb. 2007.

  • How deregulation can impact firm strategies and environmental quality in electric utilities
  • After deregulation, it is found that firms "differentiate" themselves. ie. firms in areas with customers who want green power will promote the manufacture and sale of green power techniques. Firms with customers who want the cheapest energy will strive to lower costs
  • Regulation bottled all the different types of customers into one. After regulation, the firms branched out
  • Deregulation Laws passed:
  • Public Utility Regulatory Policies Act (PURPA) in 1978
  • Energy Policy Act of 1992
  • Individual states started deregulation: California first, then many more states including Michigan. (Table 1)
  • US Department of energy was used to generate statistics on sales of green power
  • Trying to calculate Change in % of generation from renewables from variables like Deregulation, Environmental Sensitivity, Percentage of generation from coal, efficiency
  • Used a pooled OLS estimation regression. Cook-Weisberg and White Test statistics

FERC’s ‘Demand Response’ Rule Upheld by U.S. Supreme Court

G. Stohr and J. Polson, “FERC’s ‘Demand Response’ Rule Upheld by U.S. Supreme Court,” Bloomberg Politics, 25-Jan-2016. Full Decision

  • The ruling promotes (industrial) customers to cut back on power consumption during peak usage times
  • It does this by providing subsidies.
  • The case was brought on because the government is supposed to leave retail price regulation to the state level (U.S. Federal Power Act), but this ruling affects the retail price in a roundabout way
  • This ruling is supposed to help the environment but hurt utilities.

General Executive Compensation

Executive Incomes, Profits and Revenues: A Comment on Functional Specification

S. H. Baker, “Executive Incomes, Profits and Revenues: A Comment on Functional Specification,” Southern Economic Journal, vol. 35, no. 4, pp. 379–383, 1969.

Managerial Incentives and the Specification of Functional Forms

W. J. Boyes and D. E. Schlagenhauf, “Managerial Incentives and the Specification of Functional Forms,” Southern Economic Journal, vol. 45, no. 4, pp. 1225–1232, 1979.

The Determinants of Executive Salaries: An Econometric Survey

D. H. Ciscel and T. M. Carroll, “The Determinants of Executive Salaries: An Econometric Survey,” The Review of Economics and Statistics, vol. 62, no. 1, pp. 7–13, 1980.

Regulatory and Life Cycle Influences on Managerial Incentives

M. Hirschey and J. L. Pappas, “Regulatory and Life Cycle Influences on Managerial Incentives,” Southern Economic Journal, vol. 48, no. 2, pp. 327–334, 1981.

  • Need to look up Baker, Boyes and Schagenhauf, and Ciscel and Carroll's sources
  • Sampled 680 firms from data from 1977. 3 groups; industy, banking, and utilities
  • Industrial firms have least regulation and Utility firms have the most
  • Significant profit AND sales incentives found in industry and banking firms. no significant incentives found in utilities. More of a dis-incentive was found for utilities
  • Traditional profit maximization models might have no relevance to utility companies because of regulations.
  • Found that larger firms try to maximize profit while smaller firms try to maximize sales (growth), for industrial firms
  • This differentiation of goals for firm size is not found in banking and utility sectors.
  • Clear incentives for sales maximization only are present in utilities
  • Current utility regulation could result in undercapitalization

An Empirical Investigation of the Relative Performance Evaluation of Corporate Executives

R. Antle and A. Smith, “An Empirical Investigation of the Relative Performance Evaluation of Corporate Executives,” Journal of Accounting Research, vol. 24, no. 1, pp. 1–39, 1986.

Performance Pay and Top-Management Incentives

M. C. Jensen and K. J. Murphy, “Performance Pay and Top-Management Incentives,” Journal of Political Economy, vol. 98, no. 2, pp. 225–264, 1990.

  • Additionally to the more common incentives added to CEOs compensation, this paper included "Threat of Dismissal." This shows the CEOs general incentive to not be fired also plays a factor in the way they behave
  • Discussion on the feasibility of pay to performance sensitive contracts:
  • May not be feasible
  • Executives with limited resources will not commit to a contract with a high performance based pay, for fear of low pay
  • Shareholder might not want to commit to a high performance based pay for fear of too high a pay
  • Measure of CEO performance other than shareholder wealth; CEO activity, accounting measures of performance, relative performance
  • The relationship between CEO compensation and shareholder earnings is small and has fallen over the last 50 years
  • Results:
  1. CEO wealth changes by 30 cents to $1000 of shareholder wealth, stocks change by 15 cents to $1000 of shareholder wealth
  2. The average estimate of CEO dismissal concequences is 30 cents to $1000 of shareholder wealth. Total pay-performance sensitivity is 75 cents to $1000 of shareholder wealth.
  3. largest CEO incentive comes from ownership of their own stock, $3.25 to $1000 of shareholder wealth
  4. inside stockholdings do not affect pay-performance
  5. bonuses (50% of salary) do not affect sensitivity
  6. low variability of changes in CEo compensation
  7. Median CEO stockholding fell from .3% (1938) to 0.03% (1984)
  8. average standard deviation of pay changes for CEOs fell during 1934 to 1974-86 (almost $100,000)
  9. Pay performace sensitivity fell during the same years
  10. average salary plus bonus fell
  • Pay-performance of CEOs fell a lot between 1934 and 1986.
  • Political interference is probable. was regulation passed during these years?

Accounting income, stock price, and managerial compensation

R. M. Bushman and R. J. Indjejikian, “Accounting income, stock price, and managerial compensation,” Journal of Accounting and Economics, vol. 16, no. 1, pp. 3–23, Jan. 1993.

  • Look up antle and smith 1986, Jensen and Murphy 1990
  • It's not very useful
  • "The role played by earnings depends directly on its information content"

How Much Does Performance Matter? A Meta-Analysis of CEO Pay Studies

H. Tosi, S. Werner, J. Katz, and L. Gomez-Mejia, “How Much Does Performance Matter? A Meta-Analysis of CEO Pay Studies,” Journal of Management, vol. 26, no. 2, pp. 301–339, Apr. 2000.

  • States that firm size gives 40% of variance in total CEO pay and firm performance gives 5% of variance.
  • In classical firm layouts, the CEO also owns the firm, so there is no conflict of interests
  • nowadays, a corporation can be owned by thousands(stockholders), leading to conflict of interests
  • executives can be more interested in increasing firm size. This gives more pay, power, prestige, etc.
  • CEOs have more influence over size than performance. If they can correlate their bonus packages with size rather than company performance, they can benefit easier and more.
  • increased size can justify increased pay easier as well:
  • greater organizational complexity
  • more human capital required
  • a bigger hierarchy (more pay at top of layers)
  • executives are risk adverse, meaning that they will try to reduce their personal risk by decoupling their pay from the firms performance, and hopefully linking it to a more stable factor(firm size)
  • board members, who chose a compensation package for CEOs, may also benefit from a decoupled pay. Higher paid CEOs have higher paid board members
  • CEOs are in a position that allows them to more easily pursue their goals than the shareholders
  • H1: Firm performance is an important determinant of CEO compensation
  • H2: CEO compensation is largely insensitive to firm performance and primarily determined by firm size
  • Meta-analysis has strengths such as scientific rigor, little bias in the choice of studies included, objective weighting of studies, allowing moderating variables, allowing estimations of relationship stability, and more. PErformed using the Schmidt-Hunter Method
  • Dependent Variable: CEO Pay
  • methods of evaluation are Black-Scholes method, heuristic valuation, and measuring only actual stock gains.
  • Simple measures of cash comp. are a good substitute for total pay for CEOs
  • Independent Variables: Firm performance and Firm Size
  • size can be measured by sales, number of employees, total assets, etc.
  • Performance can be measured by market value relative to book value of assets, ROE, ROI, changes in market value of firm, etc.
  • 16 measures of size and 30 measures of performance were considered (table 1).
  • 4 industries were analyzed: Pharmaceutical Preparations, Semiconductors and related devices, electro-medical equipment, and food/beverage.
  • Size factors:
  • Absolute firm size(market value, assests, equity, etc.)
  • Change in size(sales)
  • Transferred Firm Size(log of market value, change in assets, etc.)
  • Performance Factors:
  • Absolute Financial Performance(total profits, etc.)
  • Changes in financial performance(Change in income)
  • stock performance(earnings per share)
  • Return on equity, short and long term
  • Return on assests
  • Market Returns
  • Internal Performance Indicators
  • Aggregate firm size variable accounts for more than 40% of variance in pay. It is important to note this is not only size factors but performance factors as well.
  • Changes in firm performance account for 4% of variance in pay
  • Changes in firm size account for 5% of the variance in CEO pay. These results are the actual factors that should be looked at
  • The paper discusses how only objective measurements can be bad and that CEO comp. should also be based on subjective qualities. This might reduce noise in the data.
  • The paper cannot explain the large variance and discusses possible solutions

Pay for performance? Government regulation and the structure of compensation contracts

T. Perry and M. Zenner, “Pay for performance? Government regulation and the structure of compensation contracts,” Journal of Financial Economics, vol. 62, no. 3, pp. 453–488, Dec. 2001.

  • in 1992/93 the SEC and congress increased regulation and visibility on CEO compensation of large firms. They are now given less tax breaks on non performance based pay and are required to report more information
  • Propositions investigated:
  1. CEO compensation levels decrease following the adoption of 162(m) (the regulations) and the SEC disclosure changes
  • All compensation components increased over the period, showing that the regulations did not change overall CEO pay levels
  • The regulations may have put pressure to slow growth or decrease salary of larger firms
  1. Salaries above or nearing the million-dollar range are less likely to increase than salaries below the million-dollar mark.
  • only suggestive results that this may be the case. nothing conclusive
  1. Firms reduce salaries above 1 million dollars because of the regulations
  • The findings show that the regulations did not significantly cut salaries (some did get cut citing the regulations, but many went up)
  1. Salaries nearing the million-dollar range increase less than salaries below the million-dollar range.
  • Salaries close to the mark have lower growth rates
  1. Performance sensitive components of compensation, such as bonus and stock-based compensation, have become more important after 1993
  • Trends seem to be consistent, no quantitative values
  1. Increased shareholder scrutiny through enhanced disclosure and 162(m) will lead to an increase in the sensitivity of pay to performance after 1993, especially for firms subject to 162(m)
  • CEO tenure is unrelated to bonus and total comp. Firm size (ln of total assets) is proportional to total comp but not bonus
  • sensitivity does increase
  1. After the regulations, the change in CEO wealth per dollar change in shareholder wealth increases, especially for million-dollar firms
  • Calculate with Jenson-Murphey statistic
  • This is true
  • Tax paying firms should be more sensitive than non tax paying firms
  • CEO performance is measured by firms in ways including:
  • net income
  • net profit
  • Profit minus nonreoccuring events
  • Earnings per share
  • sales
  • return on equity (ROE)
  • shareholder returns
  • cash flows
  • Return on assests (ROA)
  • Profit Margin
  • dividends
  • The regulations did not affect CEO comp growth, but did affect the structure. CEO comp is more sensitive to shareholders wealth now

CEO compensation, diversification, and incentives

L. Jin, “CEO compensation, diversification, and incentives,” Journal of Financial Economics, vol. 66, no. 1, pp. 29–63, Oct. 2002.

  • Examines the CEOs incentives and the firm's associated risks
  • Risk is important because it will be low in regulated industries. This ties together the differences in compensation between two industries with a quantifiable variable
  • Assumptions:
  • Both shareholders and CEOs are risk averse
  • CEOs have large stakes in their firm
  • Shareholders have diversified portfolios
  • Assume firm-specific risk to be beyond CEOs control
  • It is more costly for CEOs than for shareholders to have firm-specific risk
  • Model 1: CEO cannot trade market portfolio, result implications:
  1. Pay performance sensitivity decreases with firm-specific risk
  2. The relationship between market risk and pay performance sensitivity is ambiguous
  3. Positive relationship exists between the productivity of a CEO and pay performance sensitivity
  • Model 2: CEO can trade market portfolio, result implications:
  1. Pay performance sensitivity decreases with firm-specific risk
  • Market risk does not affect pay performance sensitivity
  • Productivity of effort and pay performance sensitivity are proportional
  • The standard measure of CEO incentives is pay-performance sensitivity
  • Risk is measured in dollars, by measuring the variance of percentage returns and multiplying by the square of the beginning of period firm value
  • Testing to determine if firm-specific risk and systematic risk have the same effect on pay performance sensitivity
  • The connection between CEO incentives and Risk:
  1. When CEOs cannot trade on market, incentive is ambiguously related to systematic risk
  2. When CEOs can trade on market, systematic risk does not effect incentive level
  • There is a relationship between firm-specific risk and incentive, but not between systematic risk and inventives.

Pay Without Performance: The Unfufilled Promise of Executive Compensation

L. Bebchuk and J. Fried, Pay Without Performance: The Unfufilled Promise of Executive Compensation. Cambridge, Massachusets, and London, England: Harvard University Press, 2004.

  • Only the first few pages of a book
  • Discusses the importance of addressing executive pay shortfalls
  • Pay needs to be associated to shareholder wealth & not too excessive.
  • Only paper to bring up moral standpoint of high CEO pay. "paying executives hundreds of times what other employees get is inherently unfair and unacceptable."
  • From 1998 to 2002, The top five executives in the ExecuComp database earned a combined salary over $100 billion

Economic consequences of the Sarbanes–Oxley Act of 2002

[1I. X. Zhang, “Economic consequences of the Sarbanes–Oxley Act of 2002,” Journal of Accounting and Economics, vol. 44, no. 1–2, pp. 74–115, Sep. 2007.]

A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002

Y. V. Hochberg, P. Sapienza, and A. Vissing-Jørgensen, “A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002,” Journal of Accounting Research, vol. 47, no. 2, pp. 519–583, 2009.

A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium

A. Edmans, X. Gabaix, and A. Landier, “A Multiplicative Model of Optimal CEO Incentives in Market Equilibrium,” The Review of Financial Studies, vol. 22, no. 12, pp. 4881–4917, 2009.

  • Neoclassical model
  • Assume that effort has a multiplicative, not linear, effect on firm value.
  • competitive assignment model
  • Implications:
  1. dollar-dollar incentives decline with firm size
  2. wealth performance sensitivity is invariant to firm size
  3. current (observed) percent-percent incentives are enough to stop destructive CEO actions
  4. firm and wealth volatility are proportional. Firm volatility does not affect incentive pay.
  5. incentive pay is usually enough to stop destructive CEO actions.

Inside the black box: The role and composition of compensation peer groups

M. Faulkender and J. Yang, “Inside the black box: The role and composition of compensation peer groups,” Journal of Financial Economics, vol. 96, no. 2, pp. 257–270, May 2010.

  • Firms select highly paid CEOs of other companies to justify their own CEO compensation package.
  • This is more prevalent when:
  • there are less similar firms
  • The CEO is the chairman of the board of directors
  • The CEO has longer tenure
  • directors are serving on multiple boards
  • most firms will choose to compare themselves to a firm with a 5.6% higher CEO salary to their best matched, not reported firm.
  • Generally, for public firms, the compensation contract is set as follows:
  1. The firms human resources department make initial pay recommendations
  2. The recommendations are reviewed and revised by the compensation committee of the BOD, who usually work with outside consultants.
  3. The committee may "benchmark" the pay against other rival firms
  4. The full board reviews and approves the contract
  • In 2006 the SEC issued a disclosure requirement. (SEC final rules 33-8732a, item 402(b)(2)(xiv))

Executive Compensation and the Role for Corporate Governance Regulation

D. L. Dicks, “Executive Compensation and the Role for Corporate Governance Regulation,” The Review of Financial Studies, vol. 25, no. 6, pp. 1971–2004, 2012.

  • Sarbanes-Oxley Act of 2002 - protects shareholders from "managerial misbehavior"
  • Governance is regulation over the executive like above. either internal or external regulation
  • increase in governance = decrease in compensation
  • Each firm must have the optimal amount of compensation/incentives and governance to control managers
  • Small firms tend to increase incentives
  • Large firms tend to increase governance
  • Executive compensation increases with firm size
  • Pay performance sensitivity(incentives) goes down with firm size
  • Governance and incentive pay are substitutes
  • Under regulation, CEO pay falls
  • Under governance, large firm's value increases and small firm's value decreases
  • More firms with talented managers take voluntary governance
  • If governance costs go up, governance decreases.
  • Because managers are a "product", if one firm has poor governance, and therefore high compensation costs, all other firms in the industry are pressured to increase incentive pay and therefore decrease governance.
  • The conclusion is a very good summary of everything

A comparison of CEO pay-performance sensitivity in privately-held and public firms

H. Gao and K. Li, “A comparison of CEO pay-performance sensitivity in privately-held and public firms,” Journal of Corporate Finance, vol. 35, p. 370+, Dec. 2015.

  • Studies CEO contracts on private and public firms over the years 1999-2011.
  • This source is mostly focused on private firms. It does not give reasons for its findings. Minimally applies to electric utility compensation
  • Conclusions:
  • CEOs in public firms are paid 30% more than CEOs in (comparable) private firms.
  • CEO pay in both firm types is proportional to firm accounting performance.
  • pay performance link is stronger in public than in private firms


H1: The shareholder monitoring hypothesis: CEO pay performance sensitivity is weaker in privately held firms than in public firms
H2: :*The CEO power hypothesis: CEO pay performance sensitivity is stronger in privately held firms than in public firms
  • CEO total compensation is given as the total of salaries, bonuses, grant date value of restricted stock awards, and grand date Black-Scholes value of granted options, and other pay (premiums for insurance policies and medical expenses).
  • Results support the view "that concentrated ownership structure substitutes for CEO performance-based compensation contracts."

Market Reactions to the Regulation of Executive Compensation

J.-M. Hitz and S. Müller-Bloch, “Market Reactions to the Regulation of Executive Compensation,” European Accounting Review, vol. 24, no. 4, pp. 659–684, Oct. 2015.