_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 4, No. 3: February 13, 2003
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Publisher: LSN Employment, Labor, Compensation & Pension Journals
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Topic of This Issue:
Executive Compensation
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T A B L E of C O N T E N T S
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NEW and FORTHCOMING ARTICLES
"Should Directors Reduce Executive Pay?"
Hastings Law Journal, Vol. 54, January 2003
RANDALL S. THOMAS
Vanderbilt University School of Law
"Restructuring Charges and CEO Cash Compensation: A
Reexamination"
Accounting Review, January 2003
DAVIT ADUT
Texas A&M University
Lowry Mays College & Graduate School of Business
WILLIAM M. CREADY
Louisiana State University
Department of Accounting
THOMAS J. LOPEZ
Georgia State University
"Managerial Pay and Governance in American Nonprofits"
Industrial Relations, Vol. 41, pp. 377-406, 2002
KEVIN F. HALLOCK
University of Illinois at Urbana-Champaign
WORKING PAPERS
"Dividend Payout and Executive Compensation in US Firms"
NALINAKSHA BHATTACHARYYA
University of Manitoba
Department of Accounting & Finance
University of British Columbia
AMIN MAWANI
York University - Department of Accounting
CAMERON K.J. MORRILL
University of Manitoba
"Managerial Power and Rent Extraction in the Design of Executive
Compensation"
LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley
School of Law (Boalt Hall)
DAVID I. WALKER
Boston University School of Law
"Incentives in the Firm and the Roots of Capitalist Myopia"
PRASHANT HEMKANT DESHPANDE
Wipro Limited - Corporate Human Resources
"Executive Compensation as an Agency Problem"
LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley
School of Law (Boalt Hall)
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"Should Directors Reduce Executive Pay?"
Hastings Law Journal, Vol. 54, January 2003
BY: RANDALL S. THOMAS
Vanderbilt University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=353560
Paper ID: Vanderbilt Law and Economics Research Paper No. 02-18
Contact: RANDALL S. THOMAS
Email: Mailto:randall.thomas@law.vanderbilt.edu
Postal: Vanderbilt University School of Law
131 21st Avenue South
Nashville, TN 37203-1181 UNITED STATES
Phone: 615-343-3814
Fax: 615-322-6631
Paper Requests:
Contact: Janis Stewart, Joe C. Davis Working Paper Series
Program, Vanderbilt University Law School, 131 21st Avenue
South, Nashville, TN 37203. Phone:(615) 322-0028. Fax:(615)
322-6631. Mailto:Janis.Stewart@law.vanderbilt.edu
ABSTRACT:
This paper examines internal pay disparities in American public
corporations and argues that wide gaps between the top and
bottom of the pay scale can, in certain circumstances, directly
and adversely affect firm value, that corporate boards should be
informed about these effects, and that they should, in some
cases, reduce internal pay differentials to address them. In
support of this thesis, it analyzes numerous empirical studies
that have shown that wide disparities in corporate pay scales
can adversely affect firm value. These studies demonstrate that,
at many types of organizations, as internal pay differentials
grow, employees and lower level managers increasingly view
themselves as being unfairly compensated in comparison to more
highly paid top management. This perception adversely affects
employee performance, productivity and willingness to work, and
thereby reduces firm value. Directors' duty of care requires
that they consider the spread between the high and low end of
the corporate pay scale in setting firm compensation levels and
act in the corporation's best interests to reduce it if
necessary to maximize firm value.
Moreover, mega-grants of stock options are primarily
responsible for these growing pay differentials. Corporate
directors are uninformed about the real costs and benefits of
these huge awards. Mega-grants of stock options to corporate
managers are unjustified if their uncertain benefits are
exceeded by their costs. As virtually no research has shown that
mega-grants of stock options' costs exceed their benefits,
directors need to more carefully determine if these programs
maximize firm value. Once again, directors' duty of care
obligates them to be reasonably informed about the value of
these plans as that constitutes material information about their
firm.
JEL Classification: K2, G3, J3, J33, J4, K22, M5
______________________________
"Restructuring Charges and CEO Cash Compensation: A
Reexamination"
Accounting Review, January 2003
BY: DAVIT ADUT
Texas A&M University
Lowry Mays College & Graduate School of Business
WILLIAM M. CREADY
Louisiana State University
Department of Accounting
THOMAS J. LOPEZ
Georgia State University
Contact: THOMAS J. LOPEZ
Email: Mailto:ACCTJL@LANGATE.GSU.EDU
Postal: Georgia State University
School of Accountancy
P.O. Box 4050
Atlanta, GA 30303-3083 UNITED STATES
Phone: 404-651-4486
Fax: 404-651-1033
Co-Auth: DAVIT ADUT
Email: Mailto:dadut@cgsb.tamu.edu
Postal: Texas A&M University
Lowry Mays College & Graduate School of Business
Wehner 401Q, MS 4353
College Station, TX 77843-4218 UNITED STATES
Co-Auth: WILLIAM M. CREADY
Email: Mailto:wcread1@lsu.edu
Postal: Louisiana State University
Department of Accounting
E.J. Ourso College of Business Administration
CEBA Building 3101
Baton Rouge, LA 70803 UNITED STATES
ABSTRACT:
Prior research generally concludes that compensation committees
completely shield executive compensation from the effect of
restructuring charges on earnings. In contrast, we find that
after controlling for the growth in annual inflation-adjusted
CEO cash compensation, compensation committees only partially
shield CEO compensation from the adverse effect of restructuring
charges on earnings, on average. In further analyses, we
identify factors associated with cross-sectional differences in
the extent of shielding. Specifically, we find that compensation
committees appear to: (1) completely shield initial and
subsequent restructuring charges for CEOs with long tenure,
provided that the firm had not recorded a charge in the two
immediately prior years, (2) provide no shielding of subsequent
restructuring charges taken by short-tenured CEOs if the firm
reported a prior restructuring charge within two years of the
current charge, (3) and partially shield the other categories of
restructuring charges. Overall, this study provides evidence
that compensation committees evaluate the context of each
restructuring in determining the extent to which they will
intervene to shield executive compensation from the effect of
these charges.
Keywords: executive compensation, restructuring charges,
compensation committee
JEL Classification: M41, J33, G34
______________________________
"Managerial Pay and Governance in American Nonprofits"
Industrial Relations, Vol. 41, pp. 377-406, 2002
BY: KEVIN F. HALLOCK
University of Illinois at Urbana-Champaign
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=316052
Contact: KEVIN F. HALLOCK
Email: Mailto:hallock@uiuc.edu
Postal: University of Illinois at Urbana-Champaign
1206 South Sixth Street
Champaign, IL 61820 UNITED STATES
Phone: (217) 333-4842
ABSTRACT:
This article examines the compensation of top managers of
nonprofits in the United States using panel data from tax
returns of the organizations from 1992 to 1996. Studying
managers in nonprofits is particularly interesting given the
difficulty in measuring performance. The article examines many
areas commonly studied in the executive pay (within for-profit
firms) literature. It explores pay differences between
for-profit and nonprofit firms, pay variability within and
across nonprofit industries, managerial pay and performance
(including organization size and fund raising) in nonprofits,
the effect of government grants on managerial pay, and the
relationship between boards of directors and managerial pay in
nonprofits.
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Dividend Payout and Executive Compensation in US Firms"
BY: NALINAKSHA BHATTACHARYYA
University of Manitoba
Department of Accounting & Finance
University of British Columbia
AMIN MAWANI
York University - Department of Accounting
CAMERON K.J. MORRILL
University of Manitoba
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=326801
Date: August 15, 2002
Contact: NALINAKSHA BHATTACHARYYA
Email: Mailto:bhattach@ms.umanitoba.ca
Postal: University of Manitoba
Department of Accounting & Finance
181 Freedman Crescent
Faculty of Management
Winnipeg, MB R3T 5V4 CANADA
Phone: 204-474-6774
Fax: 204-474-7545
Co-Auth: AMIN MAWANI
Email: Mailto:AMAWANI@SSB.YORKU.CA
Postal: York University - Department of Accounting
4700 Keele Street
Toronto, Ontario, M3J 1P3 CANADA
Co-Auth: CAMERON K.J. MORRILL
Email: Mailto:Cameron_Morrill@umanitoba.ca
Postal: University of Manitoba
I.H. Asper School of Business
Department of Accounting & Finance
Winnipeg R3T 5V4, Manitoba CANADA
ABSTRACT:
We examine the association between executive compensation and
dividend payouts of US firms. We start by hypothesizing a
negative association between dividend payout and managerial
quality on the grounds that higher quality managers have access
to more profitable investment opportunities, and therefore have
less cash available for dividend distribution. Assuming a
competitive managerial labour market, we expect managerial
quality and managerial compensation to be positively associated.
Based on these two premises, we expect a negative association
between dividend payout and managerial compensation, and indeed
find it to be valid in our sample. We find that salary, bonus
and stock option components are all negatively associated with
firms' dividend payouts. We also find a positive association
between salary and option compensation, as well as between bonus
and option compensation, thereby suggesting that salary and
bonus are complements, and not substitutes, for option
compensation.
Keywords: executive compensation, dividend, payout ratio
JEL Classification: J33, G35
______________________________
"Managerial Power and Rent Extraction in the Design of Executive
Compensation"
BY: LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley
School of Law (Boalt Hall)
DAVID I. WALKER
Boston University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=346541
Paper ID: CEPR Discussion Paper No. 3558
Date: September 2002
Contact: LUCIAN ARYE BEBCHUK
Email: Mailto:BEBCHUK@LAW.HARVARD.EDU
Postal: Harvard Law School
1575 Massachusetts Avenue
Cambridge, MA 02138 UNITED STATES
Co-Auth: JESSE M. FRIED
Email: Mailto:FRIEDJ@MAIL.LAW.BERKELEY.EDU
Postal: University of California, Berkeley
School of Law (Boalt Hall)
Boalt Hall
Berkeley, CA 94720-7200 UNITED STATES
Co-Auth: DAVID I. WALKER
Email: Mailto:diwalker@bu.edu
Postal: Boston University School of Law
765 Commonwealth Avenue
Boston, MA 02215 UNITED STATES
Paper Requests:
Contact CEPR Discussion papers, 90-98 Goswell Road, London EC1V
7RR, UK. Phone:(44 20)7878 2900. Fax:(44 20) 7878 2999.
Mailto:orders@cepr.org Fee: 5 (British Pound Sterling) /US $5 /8
euros per paper. Payment in advance is requested. Postage and
packing additional.
ABSTRACT:
This Paper develops an account of the role and significance of
managerial power and rent extraction in executive compensation.
Under the optimal contracting approach to executive
compensation, which has dominated academic research on the
subject, pay arrangements are set by a board of directors that
aims to maximize shareholder value. In contrast, the managerial
power approach suggests that boards do not operate at arm's
length in devising executive compensation arrangements; rather,
executives have power to influence their own pay, and they use
that power to extract rents. Furthermore, the desire to
camouflage rent extraction might lead to the use of inefficient
pay arrangements that provide suboptimal incentives and thereby
hurt shareholder value. The authors show that the processes that
produce compensation arrangements, and the various market forces
and constraints that act on these processes, leave managers with
considerable power to shape their own pay arrangements.
Examining the large body of empirical work on executive
compensation, the authors show that managerial power and the
desire to camouflage rents can explain significant features of
the executive compensation landscape, including ones that have
long been viewed as puzzling or problematic from the optimal
contracting perspective. The authors conclude that the role
managerial power plays in the design of executive compensation
is significant and should be taken into account in any
examination of executive pay arrangements or of corporate
governance generally.
Keywords: Corporate governance, managers, shareholders,
directors, boards, executive compensation, stock options,
private benefits of control, principal-agent problem, agency
costs, rent extraction, golden parachutes, accounting, FASB
rules, disclosure, camouflage
JEL Classification: D23, G32, G34, G38, J33, J44, K22
______________________________
"Incentives in the Firm and the Roots of Capitalist Myopia"
BY: PRASHANT HEMKANT DESHPANDE
Wipro Limited - Corporate Human Resources
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=341420
Date: December 2002
Contact: PRASHANT HEMKANT DESHPANDE
Email: Mailto:prashant.deshpande@wipro.com
Postal: Wipro Limited - Corporate Human Resources
Sarjapur Road
Doddakannelli
Bangalore, Karnataka 560035 INDIA
ABSTRACT:
Individual managers are the real actors, who shape market
outcome through key decisions they take on behalf of firms.
Their individual payoffs are determined by the internal
incentive contracts of the firm, rather than the incentives
originated purely in the marketplace. This paper explores the
effect of such incentive contracts on the time horizon for
decision-making by executives. Considering complex and
multidimensional nature of executive job, the paper employs the
Multitask Principal-agent approach developed by Holmstrom &
Milgrom for developing model outlining the mechanism of such a
choice. According to the model, a multitask agent subjected to a
performance linked incentive structure maximizes his utility
through reallocation of efforts towards the tasks with shorter
payback period, even when the firm doesn't optimize its value
due to such a choice. It also discusses why instead of
mitigating the horizon problem, as predicted by the efficient
market hypothesis, the excessive reliance on stock options in
executive compensation design exacerbates horizon problem.
Finally the paper describes the difference in mechanisms by
which, earnings based cash incentives and stock options affect
the decision horizon.
Keywords: Horizon Problem, Agency Theory, Executive
Compensation, Incentives, Stock Options, Multi-task
Principal-Agent Problem
JEL Classification: M52, J33
______________________________
"Executive Compensation as an Agency Problem"
BY: LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
JESSE M. FRIED
University of California, Berkeley
School of Law (Boalt Hall)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=364220
Date: December 2002
Contact: LUCIAN ARYE BEBCHUK
Email: Mailto:BEBCHUK@LAW.HARVARD.EDU
Postal: Harvard Law School
1575 Massachusetts Avenue
Cambridge, MA 02138 UNITED STATES
Co-Auth: JESSE M. FRIED
Email: Mailto:FRIEDJ@MAIL.LAW.BERKELEY.EDU
Postal: University of California, Berkeley
School of Law (Boalt Hall)
Boalt Hall
Berkeley, CA 94720-7200 UNITED STATES
ABSTRACT:
This paper discusses the main theoretical elements and empirical
underpinnings of a "managerial power" approach to the study of
executive compensation. We start by providing reasons to doubt
that a model of arm's length contracting can adequately explain
the compensation arrangements of top executives. We then explain
why such arrangements are likely to be influenced by executives'
efforts to extract rents and to camouflage the extent of their
rent extraction. Managers' ability to influence their
compensation arrangements is costly to shareholders because of
the rents extracted and, probably more importantly, because the
camouflaging of rents can lead to inefficient arrangements that
weaken and distort managers' incentives. We illustrate the
utility of the managerial power approach by showing how it can
help explain the observed patterns in the relationship between
power and pay, the conventional use of compensation consultants
and option plans that do not filter out windfalls, the
near-uniform use of at-the-money options, the practice of giving
executive loans and golden goodbyes, and executives' broad
freedom to unload options and shares. We conclude that executive
compensation arrangements can be usefully studied not only as an
instrument for addressing the agency problem between managers
and shareholders but also as part of the agency problem itself.
Keywords: Corporate governance, managers, shareholders,
boards, directors, executive compensation, stock options,
principal-agent problem, agency costs, rent extraction, golden
parachutes, executive loans, compensation consultants