_________________________________________________________________
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. 6, No. 3: February 10, 2005
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Publisher: Employment, Labor, Compensation & Pension Law Journals
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Editor: PAMELA PERUN
Urban Institute
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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
"The Compensation of UK Executive Directors: Lots of Carrots but
are there any Sticks?"
Competition and Change, Forthcoming
KONSTANTINOS STATHOPOULOS
Manchester Business School
SUSANNE K. ESPENLAUB
University of Manchester
Division of Accounting and Finance
MARTIN WALKER
University of Manchester
Division of Accounting and Finance
"UK Executive Compensation Practices: New Economy vs. Old
Economy"
Journal of Management Accounting Research, 2004
KONSTANTINOS STATHOPOULOS
Manchester Business School
SUSANNE K. ESPENLAUB
University of Manchester
Division of Accounting and Finance
MARTIN WALKER
University of Manchester
Division of Accounting and Finance
"Corporate Heroin: A Defense of Perks, Executive Loans, and
Conspicuous Consumption"
Georgetown Law Journal, 2005
M. TODD HENDERSON
University of Chicago
Law School
JAMES C. SPINDLER
University of Chicago
John M. Olin Program in Law and Economics
WORKING PAPERS
"Does One Hand Wash the Other? Testing the Managerial Power and
Optimal Contracting Hypotheses of Executive Compensation"
MICHAEL B. DORFF
Southwestern University School of Law
"Golden Handshakes: Rewards for CEOs Who Leave"
DAVID YERMACK
New York University
Department of Finance
"The Growth of U.S. Executive Pay"
LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
YANIV GRINSTEIN
Cornell University
Samuel Curtis Johnson Graduate School of Management
"Are Non-Profit Firms Simply For-Profits in Disguise? Evidence
from Executive Compensation in the Nursing Home Industry"
ANUP MALANI
University of Virginia
School of Law
ALBERT H. CHOI
University of Virginia
Department of Economics
S S R N I N F O R M A T I O N
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"The Compensation of UK Executive Directors: Lots of Carrots but
are there any Sticks?"
Competition and Change, Forthcoming
BY: KONSTANTINOS STATHOPOULOS
Manchester Business School
SUSANNE K. ESPENLAUB
University of Manchester
Division of Accounting and Finance
MARTIN WALKER
University of Manchester
Division of Accounting and Finance
Contact: KONSTANTINOS STATHOPOULOS
Email: Mailto:k.stathopoulos@manchester.ac.uk
Postal: Manchester Business School
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
Phone: +44 161 275 4564
Fax: +44 161 275 4023
Co-Auth: SUSANNE K. ESPENLAUB
Email: Mailto:susanne.espenlaub@man.ac.uk
Postal: University of Manchester
Division of Accounting and Finance
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
Co-Auth: MARTIN WALKER
Email: Mailto:martin.walker@man.ac.uk
Postal: University of Manchester
Division of Accounting and Finance
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
ABSTRACT:
This paper provides evidence on the level and composition of the
pay of the top executives of a sample of UK Public Listed
Companies. The study uses hand collected data on the
compensation for 698 CEO years and 2609 other-executive years
over the period 1995-2000. In order to focus on the consequences
of exceptional performance, our sample is stratified to include
sub-samples of PLCs experiencing extreme positive and negative
stock-price performance.
With regard to management compensation, we find clear
differences in the treatment of executives across our three
sub-samples. Consistent with standard contracting theory, the
executives of exceptionally well-performing firms fare better
than the executives of mid-performing firms, who in turn fare
better than the executives of poorly performing firms. In
particular, we find that the executives of exceptionally poorly
performing firms experience mean cuts in their salaries and
bonuses. That trend also applies to equity-based compensation.
It should be mentioned though that a time-series investigation
reveals an increased participation and value in the equity-based
schemes provided to CEOs and other executives of poorly
performing firms. This is against the agency theory prediction
that agents refrain from risk sharing in more volatile corporate
environments.
With regard to loss of tenure, we find, consistently with
current literature, that the CEOs of poorly performing firms are
significantly more likely to be dismissed. This turnover though
does not seem to directly affect the CEOs' emoluments during the
year of departure. We argue that the effect of turnover on CEOs'
wealth depends on whether departure affects their ability to
find an equally lucrative new job.
JEL Classification: G30, J30, J33
______________________________
"UK Executive Compensation Practices: New Economy vs. Old
Economy"
Journal of Management Accounting Research, 2004
BY: KONSTANTINOS STATHOPOULOS
Manchester Business School
SUSANNE K. ESPENLAUB
University of Manchester
Division of Accounting and Finance
MARTIN WALKER
University of Manchester
Division of Accounting and Finance
Contact: MARTIN WALKER
Email: Mailto:martin.walker@man.ac.uk
Postal: University of Manchester
Division of Accounting and Finance
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
Phone: +44 161 275 4008
Co-Auth: KONSTANTINOS STATHOPOULOS
Email: Mailto:k.stathopoulos@manchester.ac.uk
Postal: Manchester Business School
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
Co-Auth: SUSANNE K. ESPENLAUB
Email: Mailto:susanne.espenlaub@man.ac.uk
Postal: University of Manchester
Division of Accounting and Finance
Crawford House
Oxford Road
Manchester M13 9PL, UNITED KINGDOM
ABSTRACT:
This paper examines the executive compensation practices of
listed U.K. retailing companies. We compare New Economy
retailers (e-commerce/dot.coms) to more traditional retailers
operating in the "Old Economy". We also discriminate between
recently floated retailers and their more seasoned counterparts.
Using a sample of remuneration contracts for 549 directors in 72
listed U.K. companies in the New and Old Economy, we investigate
the structure and level of executive (and non-executive)
compensation defined as the sum of salary, annual bonus, and the
values of executive stock options and long-term incentive plans
(LTIPs). We investigate the extent to which the contract
features are determined by firm characteristics, economic
sector, and governance/ownership factors. In contrast to the
U.S., where almost all executive stock options are issued at the
money, there is a greater variety of practice in the U.K. with
some options being granted substantially in the money. We,
therefore, pay special attention to this U.K. institutional
feature by producing a model designed to explain the
cross-sectional variation in the moneyness of stock options at
the date of issue. We also examine the determinants of a number
of other contract features. These are: the time to maturity of
the executive stock options, the leverage of the compensation
package, the ratio of long-term pay relative to short-term pay,
and pay performance sensitivity. We find that differences in
compensation arrangements can be explained to a significant
extent by differences in firm size, growth/growth opportunities,
firm financial policy, ownership characteristics, and governance
arrangements. We also find some systematic differences between
the compensation arrangements of CEOs and other executives.
JEL Classification: G30, G34, J33
______________________________
"Corporate Heroin: A Defense of Perks, Executive Loans, and
Conspicuous Consumption"
Georgetown Law Journal, 2005
BY: M. TODD HENDERSON
University of Chicago
Law School
JAMES C. SPINDLER
University of Chicago
John M. Olin Program in Law and Economics
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=597661
Paper ID: U Chicago Law & Economics, Olin Working Paper No. 221
Contact: JAMES C. SPINDLER
Email: Mailto:jspindle@uchicago.edu
Postal: University of Chicago
John M. Olin Program in Law and Economics
1111 E. 60th Street
Chicago, IL 60637
Co-Auth: M. TODD HENDERSON
Email: Mailto:mhenders@law.uchicago.edu
Postal: University of Chicago
Law School
1111 E. 60th St.
Chicago, IL 60637 UNITED STATES
ABSTRACT:
We argue that firms undertake to reduce employee savings in
order to avoid final period problems that occur when employees
accumulate enough wealth to retire and leave the industry.
Normally, reputation constrains employee behavior, since an
employee who "cheats" at one firm will then find herself unable
to get a job at another. However, employees who have saved such
that they no longer care about continued employment will act
opportunistically in the final periods of employment, which can
destroy much or all of the surplus otherwise created by the
employment relationship. We believe that this sort of final
period cheating creates significant problems for employees in
positions of delicate trust, particularly those with a large
variable compensation component, such as corporate CEOs,
securities professionals, and even corporate lawyers.
Payment in-kind (perks), deferred compensation (corporate
loans), and the encouragement of employees' conspicuous
consumption - either through screening, inculcation, or
signaling - are strategies that firms enact to combat this final
period problem of employee cheating. Employees who reduce
savings are more reliable over the long term than employees who
do not, since reduced savings makes employees more dependent
upon remaining employed into the future; these employees will
invest in their reputations by engaging in less cheating. We
make an analogy to drug dependency: the employee who consumes
all her resources immediately enjoys large present utility, as
does the addict, but is ultimately dependent on the firm to
provide her with the same opportunities in the future. Applying
the theoretical framework we develop to the real world can help
explain much of observable behavior and compensation practice.
Thus, far from being prima facie evidence of corporate fraud -
the picture painted by the media, academia, and prosecutors at
recent corporate trials - high levels of in-kind compensation,
corporate loans, and personal consumption may be evidence of
optimal incentivization, where principal and agent have
contracted (explicitly or implicitly) for just the amount and
type of remuneration that maximizes their joint welfare.
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Does One Hand Wash the Other? Testing the Managerial Power and
Optimal Contracting Hypotheses of Executive Compensation"
BY: MICHAEL B. DORFF
Southwestern University School of Law
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=574861
Date: August 10, 2004
Contact: MICHAEL B. DORFF
Email: Mailto:mdorff@swlaw.edu
Postal: Southwestern University School of Law
Los Angeles, CA 90005 UNITED STATES
ABSTRACT:
The recent series of corporate scandals has heated up the
executive compensation debate. Those who warn of problems with
the current system marshal evidence of structural pressures on
directors to comply with executives' desires. They also point to
common elements in compensation packages that seem poorly
designed to induce managers to run the corporation efficiently.
Defenders of the status quo point to apparent correlations
between pay and performance, as well as to the increasing number
of independent directors. The evidence on both sides is indirect
and therefore vulnerable to alternative explanations.
The absence of conclusive data in the executive compensation
debate is understandable. Direct evidence of boards' cooption
would require the unlikeliest of confessions; directors are not
apt to admit breaching their fiduciary duties in giving in to
their chief executive's pay demands. On the other side of the
debate, it is very difficult to prove a negative, that directors
do not bend to their CEOs' will in setting managers' pay.
This article attempts to fill this evidentiary gap with an
empirical test. The article employs a classroom model of the
pay-setting process, making it possible to isolate a single
variable - here, managerial power - and measure its impact. In
this study, executive power had a dramatic impact on
compensation, producing salaries that were not only much higher
than those under a pure market regime but, in fact, demonstrably
excessive. The results support critics of the existing regime
and argue for legal changes to reduce chief executives' power
over directors.
______________________________
"Golden Handshakes: Rewards for CEOs Who Leave"
BY: DAVID YERMACK
New York University
Department of Finance
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=594423
Date: August 2004
Contact: DAVID YERMACK
Email: Mailto:dyermack@stern.nyu.edu
Postal: New York University
Department of Finance
MEC 9-56
44 West 4th Street
New York, NY 10012-1126 UNITED STATES
Phone: 212-998-0357
Fax: 212-995-4220
ABSTRACT:
This paper studies separation payments made when CEOs leave
their firms. In my sample of Fortune 500 companies these
packages are widespread and lucrative. Almost 80 percent of CEOs
receive separation pay, and its mean present value exceeds $4.5
million. Severance is positively associated with future pay that
CEOs might expect until age 65, and is higher when CEOs depart
involuntarily. Shareholders react negatively when separation
agreements are disclosed, but only in cases of voluntary CEO
turnover. Some evidence suggests that severance pay acts as a
bonding device between the board and CEO, while other evidence
accords with theories of rent extraction.
JEL Classification: G34
______________________________
"The Growth of U.S. Executive Pay"
BY: LUCIAN ARYE BEBCHUK
Harvard Law School
National Bureau of Economic Research (NBER)
YANIV GRINSTEIN
Cornell University
Samuel Curtis Johnson Graduate School of Management
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=648682
Date: January 2005
Contact: LUCIAN ARYE BEBCHUK
Email: Mailto:bebchuk@law.harvard.edu
Postal: Harvard Law School
1563 Massachusetts Avenue
Cambridge, MA 02138 UNITED STATES
Phone: 617-495-3138
Fax: 617-496-3119
Co-Auth: YANIV GRINSTEIN
Email: Mailto:yg33@cornell.edu
Postal: Cornell University
Samuel Curtis Johnson Graduate School of
Management
Ithaca, NY 14853 UNITED STATES
ABSTRACT:
This paper examines both empirically and theoretically the
growth of U.S. executive pay during the ten-year period
1993-2002. During this period, pay has grown much beyond the
increase that could be explained by changes in market
capitalization and industry mix. Had the relationship of
compensation to market capitalization and industry
classification remained the same, mean compensation would have
increased by less than 20% of its actual increase. During this
period, there has been a great increase in the amount of
equity-based compensation in both new economy and old economy
firms that was not accompanied by a substitution effect, i.e., a
reduction in the growth of other types of compensation. In
addition, the connection between high compensation to top-five
executives paid by public companies during the decade has added
up to about 250 billion, with the economic significance of pay
steadily increasing; during 1998-2002, the aggregate
compensation paid by public firms to their top-five executives
was about 10% of the aggregate profits of public firms, up from
about 6% during 1993-1997. After presenting evidence about the
growth of pay during the considered decade, we discuss
alternative explanations for it. We examine how this growth
could be explained under either the arm's length bargaining
model of executive compensation or the managerial power model.
Among other things, we discuss the relevance of the parallel
rise in market capitalizations and in the use of equity-based
compensation.
______________________________
"Are Non-Profit Firms Simply For-Profits in Disguise? Evidence
from Executive Compensation in the Nursing Home Industry"
BY: ANUP MALANI
University of Virginia
School of Law
ALBERT H. CHOI
University of Virginia
Department of Economics
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=617362
Date: September 26, 2004
Contact: ANUP MALANI
Email: Mailto:amalani@virginia.edu
Postal: University of Virginia
School of Law
580 Massie Road
Charlottesville, VA 22903 UNITED STATES
Phone: 434-924-3129
Co-Auth: ALBERT H. CHOI
Email: Mailto:AHC4P@VIRGINIA.EDU
Postal: University of Virginia
Department of Economics
114 Rouss Hall
P.O. Box 400182
Charlottesville, VA 22904-4182 UNITED STATES
ABSTRACT:
It is well-established that non-profit hospitals employ
performance bonuses with much lower frequency than for-profit
hospitals. Weisbrod (1999, 2003a, 2003b) suggest that this
implies that principals of non-profit and for-profit firms have
different objectives or purposes. Brickley and Van Horn (2002)
dispute the different-objectives hypothesis. They present
evidence that the salaries and turnover of executives at
non-profit hospitals reward financial performance but not
altruistic activities. Employing a unique data set of executive
compensation at 2,700 nursing homes in 2001 and 2002, this paper
improves on Brickley and Van Horn's analysis in three important
ways. First, we provide an explanation for how non-profit firms
and for-profit firms may both seek to reward financial
performance but write different executive compensation
contracts. This explanation relies upon tax penalties on the use
of financial rewards for executives by non-profit firms. Second,
we introduce direct comparisons of wages at non-profit and
for-profit facilities as well as superior controls for quality
of patient care and the risk profile of patients. Third, we
consider the implications of observed patterns in executive
compensation for alternative theories of non-profit behavior,
such as quality/quantity maximization. We conclude that
executive compensation at non-profit firms supports that the
hypothesis that principals at non-profit firms either care about
profits just like principals at for-profit firms (the strong
version of the for-profit-in-disguise model) or behave as if
they do (the weak version).