Obscured transparency? Compensation benchmarking and the biasing of executive pay

Abstract

The disclosure of compensation peer groups is argued to provide shareholders with valuable information that can be used to scrutinize CEO compensation. However, research suggests that there are substantial incentives for executives and directors to bias the compensation peer group upward such that the CEO can extract additional rent. We leverage the idea that reciprocated peer nominations are unlikely to be biased in order to construct counterfactual peer groups that allow us to measure the bias of disclosed peer groups.Analyses of eleven years of comprehensive data on compensation peer groups demonstrate that the average firm uses an upwardly biased peer group. The size of the bias increases when incentives and opportunities to do so are more pronounced. Specifically, results show that bias is larger when financial targets are not met and when exercising discretion in the selection of peer firms is justifiable. More importantly, upward bias in compensation peer groups is highly predictive of an increase in CEO compensation -suggesting that there is a strong incentive for CEOs to strategically select peers. Finally, while average peer group bias has gone down in recent years, the predictive effect of bias on pay has gone up. These findings call into question the practical impact of recent efforts to introduce greater transparency into the process for determining executive compensation.

Balanced but not fair: Strategic balancing, rating allocations, and third-party intermediaries

“…This study complements prior studies that find that comparison may be used strategically by actors for self-interested gains (e.g. De Vaan, Elbers and DiPrete, 2018;Porac, Wade, and Pollock, 1999), by extending the examination to strategic action by third-party intermediaries.…”

“…Prior literature has focused firm-specific attributes rather than on those related to the rater itself as sources of comparison (e.g. Boivie et al, 2015;De Vaan, Elbers and DiPrete, 2018), but I provide evidence that comparison can also be based on subjective outcomes specific to the actor doing the comparisons.…”