The Effect of Mergers, Divestitures, and Board Composition on CEO Compensation before and
after the Financial Crisis
Ralph Sonenshine, Nathan Larson, and Michael Cauvel
ABSTRACT
This paper revisits the determinants of CEO compensation using recent data (covering 125 firms
from 2003 to 2012) spanning the 2008 financial crisis. Overall, consistent with earlier studies,
we find firm size and board composition to be the most consistent indicators of CEO pay.
However, pay becomes more performance-oriented in the years after the financial crisis, which
may reflect tighter governance. We give particular attention to the role played by changes in the
CEO’s scope due to mergers and divestitures – the latter has seldom been considered before. We
also investigate how these factors differ by industry.
JEL Codes: G34, G3, M12, M41
Key words: mergers and divestitures, CEO compensation, board composition, stock market
performance
I. Introduction
Over the past twenty-five years CEO compensation of the top 350 firms in the U.S. has grown
875%, or more than twice the 354% growth in wages of the average worker.1 This rapid increase
appears even more dramatic when option and stock awards to CEOs are considered, and it outstrips
the growth in pay of other highly paid workers. This trend has sparked renewed interest in
understanding the factors that determine CEO compensation and whether changes in these factors
impact the recent surge in pay. Much of the debate centers on whether CEO pay is earned (for good
performance and productivity) or captured (by extracting rents from a weak board). The first view
predicts that pay should be linked to observable measures of firm performance, such as stock price
and earnings, in order to provide CEOs with incentives; the latter suggests that pay depends on the
availability of rents and the bargaining power of the CEO vis-à-vis the board and shareholders.
At the same time, it is a well-established, empirical fact that size matters: all else equal, CEOs
of larger firms are paid more. Both schools of thought on pay can reconcile this fact, but with
different explanations. If one believes in pay for performance, then one argues that larger firms attract
more talented chiefs. Pay for performance amplifies a CEO’s productivity by scaling up the
resources under his control, or demand stronger incentives to keep leadership on the straight and
narrow. Under the rent-seeking view, larger firms are harder for the board to monitor and offer more
opportunities for the CEO to skim. Therefore, as Core et. al. (1999) note CEO compensation may be
expected to be a function of firm size, complexity, growth opportunities, and board structure, as well
as firm performance and stock market volatility.
One highly visible way for a CEO to influence his firm’s size (and so perhaps his pay) is with
1
See http://www.epi.org/publication/ceo-pay-2012-extraordinarily-high/.
1
mergers and divestitures. Ideally, any link between an acquisition or divestiture and CEO pay should
be related to whether the deal improves shareholder value. However, because mergers grow a firm
and divestitures shrink it, the strong link between size and pay may play a role as well. Furthermore,
the fact that mergers and divestitures are large, concrete changes for which the CEO can credibly and
publicly take responsibility may prompt CEOs to pursue potentially questionable acquisitions rather
than more incremental changes in a firm’s size.
This paper studies how mergers and divestitures affect executive compensation over a tenyear period. The sample straddles the financial crisis of 2008, so we can test whether compensation
changes before and after the crisis, and if so, whether changes in the impact of mergers and
divestitures are partially responsible. Furthermore, by gathering data on board composition, we can
examine how changes in CEO pay are mediated by stronger corporate governance, both generally and
in relationship to mergers and divestitures.
Our results confirm the strong link between firm size and executive compensation. Similarly
to other studies, we find an elasticity from size to pay of roughly 0.25; however, the elasticity appears
to be lower after the financial crisis than it was in 2008 and the five years prior. After controlling for
firm size, we find that merger announcements have a positive effect on certain measures of CEO
compensation, yet merger size actually has a small, negative effect. Our findings on divestitures, in
contrast, are inconclusive.
The layout of the paper is as follows. Section II reviews the relevant literature. Section III
discusses our data and empirical strategy. Section IV presents our regression results, and Section V
provides some concluding remarks.
II. Literature Review
2
There are two prevailing schools of thought on what determines CEO pay. The principalagent view (as articulated by Core et. al. 2003, among many others) suggests that boards design CEO
compensation contracts so as to provide incentives for CEOs to work hard and maximize shareholder
value. Alternatively, the managerial power view (Bebchuk and Fried 2003) asserts that CEOs exert
influence over their boards that effectively allows them to participate in setting their own pay. The
two approaches suggest different explanations for large pay packages; under the principal-agent
approach, high average levels of pay may be necessary to compensate the CEO for the risk he bears
by having his compensation tied to firm performance (via stock and options), whereas under the
managerial power approach high pay might indicate weak corporate governance – specifically, a high
degree of leverage for the CEO over the board and compensation committee. Crystal (1991) argues
that boards of directors over-compensate senior executives because outside directors are hired by the
CEO and can be removed by the CEO. Likewise, Lambert et al. (1993) and Boyd (1994) find a
positive relation between CEO compensation and the percentage of the board composed of outside
directors. However, Finkelstein and Hambrick (1989) conclude that compensation is unrelated to the
percentage of outside directors on the board. Conyon (2006) provides a survey of the evidence
supporting these alternative perspectives.
Empirical evidence for the managerial power argument has focused on linking CEO pay to
measures of board capture or weak corporate governance. Chhaochharia and Grinstein (2009) show
that when new standards for board independence were introduced in the wake of corporate scandals
in the early 2000s, CEO pay declined disproportionately at firms most affected by the new rules. In a
sample of IPO firms, Conyon and He (2004) find that CEOs with large stakeholders on the board
(who are presumably stronger monitors) get pay packages tied more closely to firm performance (less
3
cash and more equity). However, the evidence is not uniform; for example, Boyle and Roberts (2013)
find that CEOs of New Zealand firms who sit on the board compensation committee are paid less
than those who do not.
Meanwhile, there is a substantial body of empirical evidence that CEO pay is increasing in
firm size (Kostiuk 1989, Murphy 1985); typical estimates put the elasticity of pay with respect to size
at 0.25 (so a 10% increase in size is associated with a 2.5% increase in pay). Under the principalagent perspective, this relationship can be seen as reflecting the need to give the CEOs of larger firms
incentives commensurate with the larger economic impact of their actions (Gayle and Miller 2009).
In contrast, the more cynical view of the managerial power approach would be that larger firms
present CEOs with more opportunities to carve out rents (Bebchuk and Fried 2003).
This empirical relationship adds nuance to a concern with older roots: namely that CEOs are
interested in empire-building for its own sake. Writers, such as Marris (1964) and Aoki (1984) argued
that, unencumbered by external constraints, executives are more interested in increasing firm size
than maximizing shareholder value. Tosi et al. (2000) attributes this in part to the idea that CEOs can
exert more complete control over firm size than performance.
In light of this empirical evidence, a growing theoretical literature has attempted to elaborate
on the reasons that firm size and CEO pay might be linked. Rosen (1992) suggests that the marginal
productivity of a CEO may scale up with firm size because his decisions affect how a larger pool of
employees and resources are deployed. When this is so, competitive labor markets will tend to match
more talented CEOs with larger firms where they are paid according to their productivity,
establishing a positive association between size, CEO ability, and pay. Baker and Hall (2004) extend
4
this theory and take it to the data, finding support for the conjecture that CEO productivity rises with
firm size. Building on these results, Gabaix and Landier (2008) develop a competitive equilibrium
assignment model of the market for CEO talent and show that calibrated predictions of pay can help
to explain not only the size-pay correlation but also time series and cross-country patterns in pay.
Tosi et al. (2000) concur that reasons for the size-pay correlation include greater complexity, more
stratification, and greater human capital at larger firms.
Given the association between firm size and CEO compensation, it is not surprising that
actions that change a firm’s size appear to have consequences for pay. Mergers and divestitures are
highly visible actions that a CEO can take to grow or shrink his firm, respectively; if he expects these
actions to be rewarded or punished in future compensation, there may be a temptation to make
decisions that are not aligned with maximizing firm value. On the question of mergers, it has long
been suspected that CEOs may be prone to empire-building at the expense of shareholder value. This
view is bolstered by considerable empirical evidence that stock markets treat merger announcements
as negative news for the acquiring firm and that acquirers tend to overpay for their acquisitions
(Moeller et al. 2004).
A number of studies have found that CEOs tend to be rewarded for mergers with higher pay
(Hartford and Li 2007, Grinstein and Hribar 2004, Yim 2013). Harford and Li (2007) find that growth
via internal capital investments is not similarly rewarded and suggest that, for some reason, mergers
give CEOs particular leverage in bargaining with boards for better pay. Yim (2013) shows that the
pay increase in the year after an acquisition is retained in subsequent years (thus strengthening the
incentives of all CEOs to complete mergers, but particularly younger ones who will enjoy these gains
over a longer career horizon). If CEOs pursued only mergers that were in their shareholders’ interest,
5
then rewarding them for mergers might be appropriate. Harford and Li (2007) address this by
examining the relationship between CEO pay and his firm’s post-merger performance. They find that
the overall pay gain from mergers conceals an asymmetry: CEOs are rewarded for mergers that turn
out well but are not punished for mergers that turn out poorly. One conceivable explanation is that
captured, or partially captured boards, tend to insulate CEOs from the downside consequences of
their mistakes. In fact, there is a body of evidence indicating that unwarranted generosity after
mergers is exacerbated by weak corporate governance (Harford and Li 2007, Grinstein and Hribar
2004). Grinstein and Hribar (2004) find that weaker boards tend to grant larger bonuses for mergers.
Harford and Li (2007) show that CEOs are punished for poor post-merger performance when the
board is strong. Furthermore, CEOs with weaker boards tend to make deals that are larger and less
profitable (as judged by market reaction) (Harford and Li 2007), suggesting that they may not
anticipate consequences for failure.
In contrast with the healthy literature on mergers, there is relatively little evidence on how
divestitures and other decisions to shrink the firm affect CEO pay. In principle, divestitures should be
rewarded or punished, just as with mergers, on the basis of their effect on shareholder value. Bebchuk
and Grinstein (2005) find the asymmetric result that increases in firm size lead to higher pay, but
decreases in size (measured either by sales or market capitalization) do not cause pay to fall. In one of
the few studies to focus explicitly on divestitures, Haynes, Thompson, and Wright (2007) examine
panel data from British firms. They find that in general, CEOs are punished for divestitures via the
robust link between firm size and pay, suggesting that CEOs will have little incentive to downsize
even when it is the right thing to do. However, firms with strong boards are an exception to this rule:
they tend to reward CEOs for divestitures.
6
This paper then examines the influence of mergers and divestitures on CEO pay. As part of
the analysis, we also assess the influence of board composition and the way these factors have been
changing over time, particularly pre and post financial crisis.
III. Data and Empirical Methodology
This paper analyzes CEO compensation for a set of 123 U.S. companies over a ten-year
time period between Jan 1, 2003 and December 31, 2012. In order to assess the effect of large
mergers and divestitures, the sample was restricted to companies that engaged in a merger or a
divestiture with a transaction value of $1 billion or more. Data on merger and divestiture values
and announcement dates were found using the SDC Thomson database. The data set includes 97
companies that engaged in a merger or divestiture and 26 other companies that did not engage in
a large merger (>$1 million) during the ten-year time span. Each of the 26 companies was
selected because it is a leading competitor for one of the 97 merging companies2.
CEO compensation was measured in four ways:
salary, total current compensation
(salary plus bonus), TDC 1 (Total Direct Compensation 1), and TDC 2 (Total Direct
Compensation 2).
Compensation data was taken from the Compustat database.
TDC 1
estimates the value of total compensation realized by the executive in a given year. This is the
sum of salary, bonus, the value of restricted stock granted, the total value of stock options
exercised, and the value of long-term incentive payouts. Thus TDC 1 comprises the value of total
compensation awarded (but not necessarily realized) to the executive that year. TDC 2 estimates
2
For many of the 97 companies, we could not find a key publicly-held competitor that did not engage in a large
merger during the ten-year time span.
7
the value of total compensation using the same method except it replaces the value of restricted
stock granted with the net value of stock options exercised. As Kaplan and Rauh (2010) explain:
“. . . TDC 2 will be closer to an executive’s true adjusted gross income while TDC 1 will more
closely approximate the compensation a company’s board expected to pay the executive”.
Firm size was measured using the firm’s sales. We also estimated the effect using firm
market capitalization and found similar (unreported) results. We chose firm sales because the Rsquared regression results were higher when using firm sales versus market capitalization.
We also investigated the effect of profitability on CEO pay to explore whether the link
between pay and performance. Profitability measures along with firm sales were taken from the
Compustat database. We used earnings per share from operations. We expect earnings per share
to have a positive effect on incentive compensation. We also used the firm’s annual stock
market performance as an independent variable. We tried both total and net stock market
performance (subtracting out the benchmark index annual performance), but did not find
differences in significance between the variables.
In addition, we used dummy variables to identify the year that the CEO was hired and
whether the CEO was hired from inside the firm or the outside. The hypothesis is that incentive
compensation will be lower if the CEO is a new hire, as incentives may be built in over time.
Also, we hypothesize that CEOs hired from the outside may receive higher salary or incentive
compensation than inside hires, based on the theory that the firm faces more competition for
outside hires (both from the CEOs’ current employers and from other firms trying to hire them).
Finally, we examined board composition using the Risk Metrics database. Each board
8
member is categorized in this database as being an employee, linked (affiliated3), or independent.
It has been assumed that the higher the percentage of affiliated board members the higher the
CEO compensation, though statistical studies have not completely borne this out. (See Hallock
1997; Core et. al. 1999, and Fich and White 2003.) If there is no registered linkage, then the
board member is either classified as an outside member, independent, or an employee member.
III.a. Summary statistics
Table 1 shows company sales and compensation by industry. From the table we see that
the sample is fairly well dispersed between industries. The consumer products, technology,
industrial, and healthcare sectors each accounted for 15% to 17% of the sample. The oil and gas
and financial segments were 12% and 11% of the total, while the utility, retail, and transportation
sectors were 6%, 5%, and 2% of the total.
From Table 1 we see the highest average salaries among sampled firms are paid in the
consumer packaged goods industry, followed by the retail industry. One of the commonalities
between these two industries is that they are relatively non-cyclical. The cyclical industries, such
as oil and gas, industrial, and technology industries each pay lower salaries but higher stock and
option compensation, as shown in TDC 1 and TDC 2.
Companies in the financial sector are the
largest as measured by market capitalization, while companies in the utility and transport sectors
maintained the lowest market capitalization. The retail sector had the highest compensation
using TDC 1 and TDC 2, as well as total current compensation.
3
Refers to a board of director’s member, who may be either a retired employee or one who
does business with the organization on which he/she serves as a member of the board. (See
Economic Research web site http://www.erieri.com/glossary/term/affiliated%20director/45)
9
Figure 1 shows annual pay by compensation category.
Here we see increasing
compensation for all categories over the first three (2003-2005) or six years (2003-2008) of the
sample. A sharp decline in the compensation level in each of the categories, except salaries, then
occurs around 2009. The compensation categories that include stock and option grants (TDC 1
and TDC 2) show a time trend similar to overall stock market performance over the period:
rising through the first half of the decade and then declining in the years leading up to and
including the recession of 2008/2009, before recovering around 2010. TDC 2 declined
particularly sharply since this compensation category includes stock options exercised, and is
therefore closely tied to contemporaneous market performance. TDC 1 declined more gradually,
as TDC 1 includes stock options awarded. We also see in Figure 1 that average salary increased
slightly (from $1.0 million to $1.3 million), while total current compensation (salary plus bonus)
actually fell between 2003 and 2012. In contrast with the decline in TDC 2, which is sharpest in
2008, the declines in total current compensation and TDC 1 begin in 2006, preceding the
recession.
Figure 2 shows the annual number of merger announcements and divestitures, while
Figure 3 shows the average transaction value of merger announcements and divestitures. We see
from Figure 2 that merger announcements increased for the first three years of the sample period
and then declined over the last four years of the sample (2009-2012) to the 2003/2004 level.
Divestiture announcements remained steady between two and five for the first six years of the
sample and, like merger announcements, declined significantly in 2009. There were then a large
number of divestitures that occurred in 2011.
Table 2 shows the total number of mergers and divestitures by industry as well as the
10
average and relative merger value by industry. Here we see that the largest number of mergers
occurred in the technology industry, while the highest merger values occurred in the financial
industry.
Also, we observe that the high relative merger value (merger value / market
capitalization) occurred in the utility sector. Regarding divestitures, we see that the consumer
sector accounted for the largest number and largest value of divestitures.
From Figure 3 we see that, in addition to the growing number of mergers between 2003
and 2005, the average merger value was also growing larger. Merger value then declined but
rose sharply in 2008 and 2009, suggesting a few large mergers were announced in the recession
years.
Figure 4 shows CEO board composition by year. There is a gradual but sustained trend
toward more independent board membership over the period, as the average fraction of
independent members rises from 70% to 85%. This rise is made possible by a steady decline in
both employee and affiliated board members over the ten years.
Table 3 presents summary statistics for the board composition, stock market, and control
variables used in the regression equation. We see in Table 3 that the firms in this sample on
average had a 7.0% higher stock market return than the S&P 500. This result could suggest a
selection bias in that successful firms are making acquisitions or divestitures.
We also see that outside hires accounted for 23% of the CEOs in our sample; in addition,
13% of CEOs were new hires (in their first year with the company). Finally, note that 79% of the
directors were classified by Risk Metrics as independent directors, 13.5% were employee
directors, and 6.5% were affiliated directors.
11
III.b Empirical strategy
We estimated several models of the determinants of CEO compensation following the basic
template below for firm j in year t:
(1) Compensationjt = β0+ β1lag firm salesjt-1 + β2Merge/Divestjt + β3Merger valuejt + β4 Divest. value jt +
β5lag EPSjt-1 + β6lag stock market returnjt-1 + β7lagS&P returnjt-1+ β8EmployeePercentjt +
β9AffiliatedPercentjt + β10Insidejt + β11NewHirejt + β12financial crisist + β13Industryj+ + εjt
Separate regressions were run on each of the four executive compensation measures.
These variables were logged as were the continuous independent variables shown. Merge/Divest
is a dummy variable that distinguishes between companies that engaged in a merger or
divestiture with a transaction value of greater than $1 billion during sample period. Merger and
divestiture announcements are dummy variable with one (1) used to indicate the year of a merger
of divestiture announcement, and zero (0) the year when no merger/announcement merger was
made. The merger value and divestiture values refer to the transaction value as reported at the
time of the merger or divestiture announcement. Market capitalization refers to the market value
of the firm at the year-end. EPS refers to earnings per share from operations. EPS and stock
market return were used to examine how CEO compensation is tied to firm profitability. Net
stock margin return is the annual stock market return, including dividends, subtracting out the
return on the benchmark index (S&P 500).4
Employee percentage and affiliated percentage represent the fraction of employees and
affiliates respectively on the firm’s board; these variables are intended to assess the effect that
board composition has on CEO compensation. The coefficients for these two variables should
4
We tried both net and absolute stock market return but did not find a difference in the findings.
12
be interpreted relative to the omitted category, the percentage of board members who are
independent. Following the literature on corporate governance, we hypothesize that boards with
more affiliated members will be more vulnerable to CEO influence, and thus will dole out higher
pay. In contrast, we expect employee board membership to result in lower compensation, as
independent directors may be seeking higher pay to influence the pay at their own companies.
Finally, financial crisis is a dummy variable indicating whether compensation was awarded
before or after the onset of the financial crisis. It is equal to 0 for years up to 2007, and switches
to 1 for 2008 and subsequent years.
Control variables include two dummy variables that indicate if the CEO was a new hire
in the particular year and if the CEO is hired from outside the firm. We would expect that CEOs
hired from outside the firm would command a higher payout than CEOs hired internally. Also,
we expect new hires to receive lower compensation, partly because of lags in awarding and
exercising incentive pay, and partly because they tend to be younger and pay trends upward over
the lifecycle. Finally, we include industry and year fixed effects.
We also estimated a separate regression that included interactive terms between financial
crisis and lag EPS, merger value, log firm sales, stock market returns, and S&P returns regressed
against the four compensation variables. The intent of these regressions is to examine the joint
effect between the financial crisis and merger value, as well as other covariates of interest.
Finally, in a fifth regression we created interaction variables between merger value and
five of the industry terms (the industries with the largest frequency in the sample). We did this
to assess differences in the merger effect on CEO compensation by industry. Also, we wanted to
assess whether potential findings regarding the impact of merger value on CEO compensation
13
are driven by one or two industries.
IV. Results
Table 5 shows the results from the regression equation for the four dependent variables
(salary, total current compensation, TDC 1, and TDC 2). All continuous variables except for
employee and affiliated percentage and stock market returns5 are measured in logs, and therefore, the
parameter estimates can be interpreted as elasticities. We see in this table that the coefficient for firm
size6 (lag firm sales) is positive and significant to the one percent level for each of the dependent
variables for CEO compensation. This finding, as expected, suggests that firm size influences CEO
compensation. The coefficient for lag sales of .15 to .26 is similar to the .25 coefficient found in
other studies7. We also see the coefficient for the firm merge/divest variable, which indicates whether
the firm completed a merger or divestiture in the ten-year time period, is positive and significant
when regressed against salary and total compensation. This may be explained by the notion that
simply announcing a merger or divestiture indicates to the board that the CEO is making positive
change in the company or has the skill sets to make major changes.
From Table 5, we also see the coefficient for merger value is positive and significant when
regressed against TDC 1 and TDC 2 (but not for salary or total compensation). This finding is
consistent with other studies8, suggesting that CEOs are rewarded for larger mergers, over and
beyond the increase one would expect simply because the merged firm has grown larger. Note that
5
Many of the stock market returns were negative, so we did not log this variable.
The results were similar when firm market capitalization (logged) was used instead of firm sales; we chose to use
firm sales because the R-squared was higher when this variable was used.
7
See Kostiuk 1989, Murphy 1985.
8
See Hartford and Li 2007, Grinstein and Hribar 2004, Yim 2013.
6
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there is a substantial body of evidence indicating that merger announcements tend to depress the
stock price of the acquiring firm; this would tend to generate a negative relationship between mergers
and TDC1 and TDC2. Taking this effect into account, it is possible that boards intend to reward
CEOs more generously for mergers than indicated by our coefficients. The effect of mergers and
divestitures is asymmetric, as divestitures have no significant effect on any form of CEO
compensation. This may reflect competing effects: while divestitures are often regarded positively by
the market, with a corresponding gain in share price, they reduce the size of the firm and the scope of
the CEO, for which he may be (unfairly) punished.
The results from Table 5 also indicate that the fraction of employees on the board is
negatively related to salary and TDC 1 (with significance at the 10% and 1% levels). We also see the
coefficient for affiliated board percentage is negative and significant to the 1% in its effect on TDC 1
and TDC 2. The coefficient for affiliated percentage is also fairly large (-.79 and -1.03); implying
that a 1% increase in affiliated percentage relative to independent percentage would cause a .79% and
1.03% decrease in TDC 1 and TDC 2. In other words adding one additional affiliated member to the
board reduces CEO pay by 7.9% to 10.3%. This result is counter-intuitive since affiliated board
members are closely associated with the CEO. One possible explanation is that affiliated board
members may be less inclined to pay large salaries due to concerns of conflict of interest or being too
close to the CEO.
We find that TDC 1 and TDC 2 are linked to firm performance, but salary and total
compensation generally are not. Specifically, TDC 1 and TDC 2 receive positive, significant effects
from lagged earnings per share and from lagged stock market performance. While lagged stock
market performance also has a significant positive effect on total compensation, the effect of EPS is
15
peculiarly negative and significant (albeit small). While this provides some evidence of pay for
performance, the conclusion is somewhat undone by the large positive and significant effects of the
S&P return on TDC 1 and TDC 2, which indicates that CEOs are being rewarded for individual firm
returns on top of a reward for the rising tide of the overall market.
Controlling for other factors, total compensation fell significantly after the financial crisis. In
contrast, salaries rose significantly (but by a much smaller amount), indicating a shift away from
bonuses (and perhaps a desire to smooth out pay). However, neither TDC 1 nor TDC 29 changes
significantly post-crisis. This is a bit surprising, as one might have expected both to fall simply
because stock prices were lower, reducing the value of stock and option grants. One possible
explanation would be a countervailing increase in the volume of such grants post-crisis, perhaps with
the intention of keeping CEOs more accountable for performance.
Finally, we see that being a new hire has a negative effect on all four forms of CEO
compensation, suggesting that compensation may accumulate over time of service, with the first year
having the lowest pay. Also, we see that the coefficient for the outside hire variable is positive and
significant when regressed against TDC 1. This finding suggests that firms provide higher incentive
compensation packages in the form of stock payouts and options to CEOs that are hired from the
outside, relative to those promoted from within the firm.
Table 6 shows the regression results with merger value and other covariates interacted with
the financial crisis dummy.10 The most salient result relates to firm sales. Pre-crisis, the elasticity of
pay with respect to firm sales is positive and significant for all four measures of pay, with elasticities
9
TDC 2 declined significantly in the years leading up to the financial crisis, but then returned to a growth
trajectory post crisis.
10
There is not enough variation in the board composition variables to estimate their pre- and post-crisis effects
separately.
16
ranging from 0.12 to 0.33. After the crisis these elasticities drop significantly in all four cases. For
salaries and total compensation, the effect of this drop is to essentially wipe out any link between size
and pay. The decline is less dramatic for TDC 1 and TDC 2, but the elasticity with respect to size still
falls by roughly 40% in both cases. An optimistic interpretation would be that the crisis had a
sobering effect on boards, making them more reluctant to reward CEOs for outcomes unrelated to
shareholder value. A more cynical possibility is that CEOs were rewarded for sales growth in the
boom years but were not punished when sales dropped after the crisis.
If compensation shifted away from factors unrelated to shareholder value after the crisis, does
that mean that it became more closely tied to a CEO’s performance? The evidence suggests a weak
and qualified yes. Pre-crisis, lagged earnings per share have a negligible (often negative) and
insignificant effect on all forms of pay except TDC 1. However, their effect rises post-crisis for all
four measures of pay, significantly so for total compensation and TDC 2. Similarly, before the crisis,
lagged stock market returns have no significant effect on pay except for TDC 2. Afterwards though,
their effect rises (except for TDC 2, which remains level), with a significant increase in the effect on
salary. Thus we have qualified evidence that compensation became more responsive to firm
performance in the wake of the financial crisis.
Furthermore, there appears to be some shift away from rewarding CEO’s simply for a rising
tide in the overall market. Pre-crisis, there is some evidence that bonuses are benchmarked against
market performance (the negative coefficient on the S&P return for total compensation), but this is
belied by the large and significant positive effect of S&P returns on TDC 1 and TDC 2. Presumably
any benchmarking of bonuses is more than undone by generous (or no) benchmarking of stock and
option grants. The main change post-crisis is that this positive effect of S&P returns on TDC 1 and
17
TDC 2 is completely wiped out (although a new positive effect on salaries does emerge). This could
reflect a new emphasis on tying stock and option incentives to relative performance in the wake of the
financial crisis (among other possible explanations).
We also see in the results from Table 6 that the coefficient for the interactive term between
merger value and financial crisis is insignificant in all four regressions. This finding would indicate
that the effect of mergers did not change in the post financial crisis period.
Finally, Table 6 examines the influence of industry interacted with merger value percentage.
From these results we see that the coefficients for merger value interacted with the technology sector
had a positive effect on CEO salary, TDC 1 and TDC 2. This result would suggest that CEOs in the
technology industries receive a higher salary and stock and option-based compensation, the larger the
merger value. This finding would also indicate that the principal-agent concern relating to mergers
may be industry specific. It is also possible that higher CEO salaries and total compensation due to
mergers are warranted in the rapidly evolving technology industry, where mergers are necessary to
innovate and redefine the company. We also find that merger value percentage interacted with the oil
and gas industry has a positive effect on CEO total compensation. It is unclear why the effect in the
oil and gas industry would only show up with total compensation. We do not find any of the other
interactive terms formed between merger value and the industry to be significant in their effect on any
of the four CEO compensation variables.
V. Conclusions
We examine the determinants of CEO compensation over a ten-year period spanning the 2008
financial crisis, focusing on the effect of mergers and divestitures. After accounting for a pre-crisis
18
rise in pay followed by a crash when the crisis hit, average pay is flat over this period. This marks a
break with the twenty years prior during which CEO pay saw a rapid expansion.
Consistent with other studies, we find an elasticity of compensation with respect to firm size
of roughly 0.15 to 0.26, with a greater effect found pre-financial crisis than post-crisis. After
accounting for firm size, merger value was associated with CEO variable compensation, as measured
by TDC 1 and TDC 2. In contrast, divestiture values have no measurable effect on pay after
controlling for firm size.
Board composition also appears to influence CEO compensation with higher employee
percentage associated with lower CEO compensation, measured by salary and total compensation. In
contrast, higher employee or affiliated board membership appears associated with lower CEO
compensation, measured by TDC 1 and TDC 2. For employee board membership the result was
limited to the post financial crisis period.
Also, the results indicate that stock market returns and profitability measured by EPS may
have a greater effect on CEO compensation in the post financial crisis period, while the effect of firm
size and overall market returns diminishes. This finding suggests that CEO compensation was
influenced to a greater extent by pay for performance criteria in the post financial crisis period.
Finally, we find that the merger effect on CEO compensation may be industry-specific given
the positive effect that merger value percentage interacted with select industries (technology and oil
and gas) had on CEO salary and total compensation. In summary, while firm size appears to have the
largest effect on CEO compensation, there are other strong influences to include merger value, board
composition, industry, and short term financial performance (measured by earning per share and
stock market performance) that also appear to influence CEO pay. It is left to other studies to
19
disentangle these effects further.
20
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23
Figure 1: Annual Executive Compensation by Type (in $1,000)
24
Table 1: CEO Compensation by Industry
Industry
Frequency
Size
(Market
Cap in
Billions)
Size
(sales in
Billions)
Salary
(in
000s)
Total
Current
Compensation
(in 000s)
TDC 1
(in 000s)
TDC 2
(in
000s)
Consumer
20
$44,629
$27,417
$1,742
$4,176
$14,599
$16,988
Technology
19
$59,263
$33,698
$982
$1,786
$14,439
$19,463
Industrial
20
$36,796
$33,764
$1,278
$2,275
$10,926
$11,361
Financial
14
$76,588
$57,089
$1,144
$4,017
$17,262
$21,201
Healthcare
21
$46,417
$26,607
$1,195
$1,881
$11,200
$13,585
Oil and gas
15
$58,857
$66,217
$1,341
$2,487
$13,944
$21,825
Retail
6
$33,901
$67,533
$1,263
$2,323
$20,516
$26,128
Transport
3
$13,858
$22,485
$749
$1,221
$6,569
$9,416
Utility
7
$16,130
$10,529
$843
$1,136
$6,554
$7,865
$47,233
$36,490
$1,227
$2,480
$13,067
$16,235
Average
25
Figure 2: Annual Merger and Divestiture Announcements
Industry
Number
of
Mergers
Table 2: Merger Summary Statistics
Average Relative Merger Number
Average
Merger
Merger
Size
of
Divestiture
Size (In
Size
Stand. Divest.
Size (In
millions)
Dev.
millions)
Relative
Divest.
Size
Divest.
size
stand.
dev.
Consumer
22
$9,132
20%
$1,801
13
$18,544
9%
$8,345
Technology
40
$6,722
11%
$2,948
3
$8,949
$2,277
Industrial
22
$3,453
9%
$742
7
$8,948
3%
6%
Financial
18
$15,086
20%
$4,562
8
$2,392
5%
$494
Healthcare
32
$8,231
18%
$2,432
11
$11,054
4%
$7,460
Oil and gas
14
$10,147
17%
$3,340
6
$7,998
4%
$3,498
Retail
8
$8,367
25%
$4,266
2
$3,412
7%
$1,262
Transport
3
$1,858
13%
$570
1
$2,400
9%
-
Utility
3
$14,092
87%
$5,872
2
$10,131
7%
$7,831
162
$8,268
18%
$1,008
49
$10,249
5%
$2,480
Average
26
$,594
Figure 3: Merger and Divestiture Value by Year
27
Figure 4: Board Composition Percentage by Year
28
Table 3: Summary Statistics
Variable
Mean
Earnings Per Share
3.06
Net Stock Market Return
0.07
New Hire
Standard
Deviation
0.09
Min
Max
2.87
3.25
0.008
0.06
0.09
0.13
0.014
0.102
0.159
Outside Hire
0.23
0.018
0.19
0.27
Employee Percentage
0.135
0.003
0.13
0.14
Independent Percentage
0.792
0.006
0.78
0.80
Affiliated Percentage
0.07
0.004
0.06
0.08
.
Table 4: Summary Statistics – Merging/Divesting versus Non-Merging/Divesting Firms
Merging/Divesting
Companies
Non merging/divesting
companies
Size (Market Cap,
millions)
$55,255
$16,791
Size (Sales)
$42,293
$16,017
Salary (thousands)
$1,246
$1,198
Total Compensation
$2,629
$1,908
TDC1
TDC2
$14,091
$17,553
$9,135
$11,171
3.15
3.32
5.8%
11.1%
79%
14%
7%
81%
15%
4%
Category
EPS
Net stock market
return
IP
EP
LP
29
Table 5: Regression Results
Merge/Non merge
firms
Lag Firm sales
(logged)
Merger value (in logs)
Divestiture value
(in logs)
Lag EPS (logged)
Financial crisis
Lag Stock market
return
Lag S&P Return
Employee Percent
Affiliated Percent
Outside
New Hire
Industry Dummies
No. of Observations
R2
(1) Salary
0.08***
(0.03)
0.15***
(0.01)
0.03
(0.02)
-0.02
(0.02)
(2) Total Current
Compensation
0.11**
(0.05)
0.21***
(0.02)
0.02
(0.02)
0.02
(0.02)
-0.06
(0.06)
0.05**
(0.02)
0.04
(0.03)
-0.05
(0.25)
-0.28*
(0.16)
-0.11
(0.13)
-0.02
(0.03)
-0.16***
(0.03)
Yes
887
0.45
-0.02**
(0.01)
-0.38***
(0.04)
0.15***
(0.06)
0.03
(0.11)
0.38
(0.28)
0.33
(0.25)
0.01
(0.02)
-0.11*
(0.05)
Yes
862
0.34
(3) TDC 1
-0.03
(0.07)
0.26***
(0.03)
0.02***
(0.001)
0.01
(0.01)
(4) TDC 2
0.01
(0.07)
0.25***
(0.04)
0.014**
(0.006)
0.01
(0.01)
0.04***
(0.01)
0.03
(0.06)
0.33***
(0.08)
0.34***
(0.14)
-0.89***
(0.38)
-0.79***
(0.34)
0.20***
(0.07)
-0.26***
(0.08)
Yes
919
0.30
0.06***
(0.01)
0.01
(0.07)
0.59***
(0.10)
0.44***
(0.17)
-0.40
(0.45)
-1.03***
(0.40)
0.09
(0.09)
-0.48***
(0.10)
Yes
918
0.25
Notes: Robust standard errors are in parentheses. ***, **, and * denote statistical significance levels of 1%, 5%, and 10%
respectively. MSE denotes means square error.
30
Table 6: Regression Results – Financial Crisis Effect
Merge/Non merge
firms
Lag Firm sales
(logged)
Lag Firm sales * Crisis
(logged)
Merger value
(in logs)
Merger value * Crisis
(in logs)
Lag EPS
(in logs)
Lag EPS * Crisis
(in logs)
Lag Stock market
return
Lag stock market
* Crisis
S&P Return
S&P return * Crisis
Employee Percentage
Affiliated Percentage
Outside
New Hire
Industry Dummies
No of Observations
R-squared
(1) Salary
0.09
(0.07)
0.12***
(0.04)
-0.13**
(0.06)
0.01
(0.11)
0.01
(0.01)
-0.01
(0.02)
0.10
(0.06)
-0.26
(0.34)
(2) Total Current
Compensation
0.13*
(0.07)
0.26***
(0.03)
-0.24***
(0.06)
0.01
(0.01)
0.01
(0.01)
-0.04
(0.02)
0.13**
(0.06)
0.24
(0.16)
1.01**
(0.52)
(0.56)
(0.63
2.16***
(0.95)
-3.11***
(1.21)
0.39
(0.38)
-0.06
(0.08)
-0.34**
(0.17)
Yes
894
0.16
0.55
(0.44)
-2.35***
(0.86)
0.30
(0.88)
-2.15**
(1.10)
0.42
(0.36)
0.15
(0.13)
-0.35**
(0.18)
Yes
894
0.23
31
(3) TDC 1
0.08
(0.10)
0.33***
(0.04)
-0.14***
(0.05)
0.08
(0.08)
-0.04
(0.03)
0.05**
(0.025)
0.01
(0.01)
0.17
(0.19)
(4) TDC 2
0.06
(0.14)
0.33***
(0.04)
-0.13**
(0.05)
0.01
(0.01)
-0.01
(0.01)
0.02
(0.03)
0.05*
(0.03)
0.64***
(0.26)
0.31
(0.25)
3.45***
(1.15)
-4.12***
(1.19)
-1.01**
(0.51)
-0.78**
(0.38)
0.15**
(0.06)
0.28***
(0.08)
Yes
919
0.32
-0.03
(0.30)
4.00***
(1.48)
-5.16***
(1.92)
-0.47
(0.63)
-0.98**
(0.44)
0.03
(0.08)
-0.53***
(0.08)
Yes
918
0.26
Notes: Robust standard errors are in parentheses. ***, **, and * denote statistical significance levels of 1%, 5%, and 10%
respectively. MSE denotes means square error.
32
Table 7: Regression Results – Industries Interacted with Merger Value
(2) Total Current
(1) Salary
Compensation
(3) TDC 1
Merge/Non merge
-0.05
0.12**
0.01
Firms
(0.05)
(0.05)
(0.07)
Lag Firm sales
0.14***
0.12***
0.26***
(logged)
(0.01)
(0.04)
(0.03)
Lag EPS (logged)
Financial crisis
Lag Stock market
Return
S&P Return
Employee Percentage
Affiliated Percentage
Outside
New Hire
MergerVal*Technology
MergerVal*oil and gas
Industry Dummies
No. of Observations
Adjusted R2
(4) TDC 2
-0.04
(0.09)
0.25***
(0.04)
0.02
(0.014)
-0.53*
(0.27)
-0.01
(0.05)
0.01
(0.10)
-0.53*
(0.27)
0.10
(0.24)
0.17**
(0.06)
-0.39***
(0.04)
-0.02**
(0.01)
0.05
(0.10)
0.51*
(0.28)
0.31
(0.24)
0.04***
(0.01)
0.01
(0.06)
0.44***
(0.08)
0.33
(0.13)
-0.82***
(0.39)
-0.80***
(0.35)
0.26
(0.16)
0.01
(0.07)
0.60**
(0.10)
0.42***
(0.17)
-0.42
(0.46)
-1.06***
(0.41)
0.16
(0.13)
-0.13*
(0.05)
0.002*
(0.001)
0.01
(0.01)
0.23*
(0.14)
-0.20*
(0.11)
0.01
(0.01)
0.002*
(0.001)
0.16*
(0.09)
-0.29***
(0.11)
0.002**
(0.001)
0.01
(0.01)
0.226
(0.226)
-0.51***
(0.12)
0.002**
(0.001)
0.01
(0.01)
Yes
919
0.30
Yes
408
0.25
Yes
888
0.22
Yes
888
0.31
Notes: Robust standard errors are in parentheses. ***, **, and * denote statistical significance levels of 1%, 5%, and 10%
respectively. MSE denotes means square error.
33