With recent changes in financial reporting rules, the public can now closely scrutinize levels of executive pay—and the public is not pleased when firms that received bailout funds pay high bonuses to their leaders. Although the compensation paid to CEOs is a relatively recent political and populist rallying point, academics and industry consultants have been examining its intricacies for some time.

When the Securities and Exchange Commission (SEC) established new disclosure rules for executive compensation in 2006, firms were required to report more detail about post-employment benefits. Linda Vincent, an associate professor in accounting information and management at the Kellogg School of Management, took notice. Vincent already had a research interest in pensions. Her colleague Brian Cadman at the University of Utah had an interest in executive compensation. The new information nudged them toward a relatively unexplored area of research.

“All of a sudden we had more precise data with which to work. This idea came into our heads as the data were becoming available—we wanted to get a handle on the amount of compensation that was being provided to CEOs in the form of defined-benefit pension plans,” Vincent explains. By analyzing a mountain of this newly available data, Vincent and Cadman found that firms that provide CEOs with defined-benefit pension plans pay higher annual salaries as well as higher total compensation.

A defined-benefit pension plan provides an executive with a predetermined set payout upon retirement, often as a monthly payment. The benefit is “defined” in that the formula for arriving at the amount is determined by the employer—who is responsible for its provision. In other words, the defined-benefit pension is not dependent upon investment returns, unlike the defined-contribution, self-determined retirement plans—such as 401(k)s—on which many of us rely.

Hands-On
To get a handle on their research question, Vincent and Cadman literally had to put their hands on a great deal of data. Although some of it came from Standard & Poor’s ExecuComp database, much of it was pulled from the annual reports and proxy statements of individual companies. To make the task more manageable, the authors limited their sample to firms in the S&P 500. Vincent says that after their first look, “We were quite surprised by the number of firms that provide CEOs with defined-benefit pension plans. Much of the initial analysis was descriptive. How many firms have these plans? What is the size of the plans and their relation to other forms of compensation?”

Vincent and Cadman found that 63 percent of firms in the S&P 500 compensate their CEOs with defined-benefit pension plans, which constitute almost 11 percent of total annual compensation on average, or $1.4 million. On average, the total value of the pension plans is $10 million, and they make up almost 17 percent of the CEO’s total wealth in the firm.

For further analyses, Vincent and Cadman compared their sample to firms without CEO defined-benefit pension plans. Because the best predictor of CEO defined-benefit pension plans is whether firms offer these plans to their other employees, the authors’ second sample was drawn from firms without CEO defined-benefit plans but with defined-benefit pension plans for nonexecutives. The two samples contain firms of similar size in the same industry.

In particular, Vincent and Cadman wanted to know how defined-benefit pension plans might affect a CEO’s total compensation. When they compared 317 firms without defined-benefit plans to 317 firms with them, they found that firms that grant their chief executives a defined-benefit pension seem to do so in addition to providing other forms of annual compensation, rather than as a substitute. This means that these firms are paying out higher total compensation to CEOs than similar firms without defined-benefit pension plans—about 21 percent more than expected, according to formulas used to predict executive compensation. In addition, firms with defined-benefit pension plans pay their CEOs more across the board: higher bonuses, higher salaries, and more equity.

Pay, Regardless of Performance
“This finding is consistent across a large number of CEOs,” says Vincent. “Those with defined-benefit pension plans just have higher overall compensation.” Further, Vincent and Cadman found that increased rewards are not tied to CEO performance. Although most defined-benefit pensions are based on the CEO’s salary and bonuses in prior years—which loosely links the pension to performance, as reflected in those immediate rewards—the authors did not find evidence that the value of defined-benefit pension plans changed as a firm’s earnings waxed or waned. Vincent cautions, “Because prior work by others did not include defined-benefit plans, they could be overstating the pay-for-performance relationship.”

Vincent and Cadman’s findings have both practical and academic implications. As a benefit to industry, these analyses may prompt compensation consultants and committees to adjust their benchmarks. As a scholarly pursuit, this is the first attempt to analyze the large amount of more precise compensation data available since 2006, and it has generated many questions still to be answered in addition to the pay-for-performance question.

“Why are firms doing this?” Vincent asks. “This is just a first cut of the data. We’re already doing more analyses.” She and Cadman are exploring why some firms have defined-benefit pension plans for their rank-and-file employees but not for CEOs (and vice versa), why some plans are funded and others are not, and whether defined-benefit pension plans are more likely to be awarded to CEOs who take more risks.

“What causes these differences?” Vincent asks. “We don’t believe they are random. We’re really still just getting to know the data and what we can learn.”