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Executive pay survey

New research by Professor Raghavendra Rau of Cambridge Judge looks at CEO compensation theory and practice, drawing on academic literature over many decades.


The level of executive (CEO) pay is frequently in the headlines, as shareholders have revolted against salary and bonus levels in some embarrassing showdowns at major companies like advertising group WPP, fashion firm Burberry and consumer products company Reckett Benckiser.

There have been plenty of recent academic articles on the subject, too – particularly since the financial crisis of 2007-2008. But that wasn’t always the case.

Raghavendra Rau

Professor Raghavendra Rau

A new survey on “Executive compensation” authored by Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge Business School, finds just 25 published articles on executive pay on research database Scopus during the period 1959 to 1991, with the tally rising exponentially since then to 657 articles in the 2011-2015 period.

The survey, published in the journal Foundations and Trends in Finance, examines topics ranging from the theory and structure of executive compensation to the respective role of boards, consultants and shareholders in setting levels of executive pay.

Professor Rau discusses some of the academic findings on a hot topic that is unlikely to hibernate anytime soon back to its pre-1991 torpor:

Executive pay was fairly flat for the 30-year period after World War II, even though the firms managed by those executives grew considerably during that period. We later saw a pay explosion in the 1990s driven by stock options, followed by a marked levelling off in the past 15 years as options have been supplanted – often due to regulatory changes – by restricted stock and performance shares. Restricted stock and performance shares give executives a fixed quantity of shares with resale and transfer restrictions, and often with provisions that forfeit the shares if the manager is fired or quits.

Although there have been broad trends over time in the relative importance of different types of compensation – salary, bonus and options – we have also seen significant variation between firms in vesting periods and patterns for options. This suggests that boards look carefully at the specific characteristics of their companies and their executives, rather than adopting boilerplate-type contracts. So younger CEOs typically wait longer for their options to vest, because boards want a longer-term perspective from such a younger executive, while volatile firms or those at high risk of takeover are more likely to have more generous severance terms that reflect these risks for the executive.

Although CEO pay tends to generate more press coverage and political heat in the US and UK, in the academic literature there appears to be little geographic difference in how companies approach the theory of executive compensation. If you look at the economic rationales for studies on how to pay executives, the evidence is very consistent whether the companies studied are from the UK, China, the US, Canada or continental Europe.

Benchmarks using peer firms or a peer group of executives are common guideposts to the level of executive pay, but these have real limitations. It’s simplistic to say that a manager is overpaid just because he or she is paid above a peer benchmark, because there may be vastly different levels of responsibility or because required skill sets may be different even for firms generally seen as “peers” in the marketplace.

A company’s stock price reflects, in part, the perceived likelihood that the CEO will stay for the long haul or beat an early exit. That’s because the share price incorporates expected future cash flow – and the ability of the company’s CEO at that future date – so the share price reflects the possibility that the chief executive will be fired and replaced with someone else who may be available at the time, and whose relative ability is, by definition, currently unknown.

Like the weather, compensation policy will clearly change over time. Current policy reflects an unstable equilibrium involving managerial bargaining power, shareholder demands, and societal needs – and the power dynamic between these three entities will ebb and flow over time. Most academic studies have focused on only two of these factors, so despite hundreds of recent studies there’s still plenty of scope for more research that looks at all three.