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CEO Utility Pay Literature Review

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Revision as of 22:48, 25 January 2016 by Cleyton (Talk | Contributions) (Pay for performance? Government regulation and the structure of compensation contracts)

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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.

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

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.

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.

General Executive Compensation

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 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

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.

Executive Compensation and the Role for Corporate Governance Regulation

D. L. Dicks, “Executive Compensation and the Role for Corporate Governance Regulation,” Rev. Financ. Stud., p. hhs055, Apr. 2012.

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.

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