How Public Outrage Affects CEO Pay
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Leadership Finance & Accounting Organizations Feb 2, 2012

How Pub­lic Out­rage Affects CEO Pay

Com­pen­sa­tion changes but does not always decline

Based on the research of

Camelia Kuhnen

Alexandra Niessen

Listening: Interview with Camelia Kuhnen on CEO Compensation

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The pub­lic has been con­cerned about income inequal­i­ty for at least twen­ty years, says Camelia M. Kuh­nen, an asso­ciate pro­fes­sor of finance at Kel­logg School of Man­age­ment. Long before there was an Occu­py Wall Street, arti­cles in the press were denounc­ing exces­sive com­pen­sa­tion. What, if any­thing, she won­dered, was the effect of all this neg­a­tive press on how firms paid chief executives? 

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As it turns out, the pub­lic and the media have more influ­ence on how CEOs are paid than most of us prob­a­bly real­ized. This does not mean, how­ev­er, that the result­ing changes in how exec­u­tives were paid are nec­es­sar­i­ly a good thing. 

In order to uncov­er whether there was a link between the sen­ti­ment expressed in the news about exec­u­tive pay and how that pay was sub­se­quent­ly doled out, Kuh­nen and her col­lab­o­ra­tor, Alexan­dra Niessen, an assis­tant pro­fes­sor at the Uni­ver­si­ty of Mannheim, wrote soft­ware to crunch through a data­base of 26,000 arti­cles span­ning the years 1990 to 2010. By iden­ti­fy­ing key words that indi­cat­ed neg­a­tive cov­er­age in the con­text of stock options — back­dat­ing” was one of them, giv­en the options back­dat­ing scan­dal that broke dur­ing that peri­od — they were able to deter­mine the over­all tone of cov­er­age in each of the years they examined.

A Focus on the Wealth Gap

Because as much as the focus of pub­lic ire dur­ing this peri­od was on stock options, Kuh­nen believes that it was prob­a­bly more about the gulf between rich and poor in gen­er­al. I think the pub­lic did care about the lev­el of CEO pay,” Kuh­nen says. You see this in sur­veys done in that time peri­od. The pub­lic has cared a lot about income inequal­i­ty for the past cou­ple of decades.”

Kuh­nen and Niessen found that com­pen­sa­tion tak­en away in the form of options was replaced with salary, bonus­es, and shares of restrict­ed stock, leav­ing CEOs with the same nom­i­nal income as before.

Com­pa­nies that were attacked over options, accord­ing to the media data gath­ered, respond­ed to the pres­sure by chang­ing their com­pen­sa­tion prac­tices, often low­er­ing the amount of the options grants giv­en to CEOs. This effect was more pro­nounced for chief exec­u­tives who were younger or at firms with more inde­pen­dent boards. In oth­er words, com­pa­nies whose lead­ers were more con­cerned about their rep­u­ta­tion, or who had more pow­er to act to pro­tect that rep­u­ta­tion, were more responsive.

Yet in the wake of all this neg­a­tive press, over­all CEO com­pen­sa­tion did not decline. Kuh­nen and Niessen found that com­pen­sa­tion tak­en away in the form of options was replaced with salary, bonus­es, and shares of restrict­ed stock, leav­ing CEOs with the same nom­i­nal income as before. This shift away from options had the effect of reduc­ing the sen­si­tiv­i­ty of CEO pay to the stock per­for­mance of the firm. This is one of the rea­sons that Kuh­nen is not sure that, at least in this case, the respon­sive­ness of CEO com­pen­sa­tion to pub­lic pres­sure was a good thing.

When you shift away from options pay into, for exam­ple, salary, you dimin­ish the strength of the con­nec­tion between how a CEO is paid and how the com­pa­ny is doing,” Kuh­nen says. In oth­er words, loos­en­ing the cou­pling between pay and per­for­mance means CEOs have less incen­tive to work hard.

Shift­ing Away from Options

At the time that options were in the news in the 1990s and ear­ly 2000s, the stock mar­ket was going through peri­od­ic surges that inflat­ed the val­ue of these options, mak­ing them more vis­i­ble. But giv­en that the ori­gin of much of the public’s out­rage was income inequal­i­ty, it seems that options may have become a proxy for this inequal­i­ty. This is just one poten­tial expla­na­tion,” Kuh­nen says, but peo­ple were hear­ing in the media about man­agers receiv­ing very large option grants, and it’s pos­si­ble in people’s minds they equat­ed the pay of the CEO with the size of the option grant.”

It is not just that reduc­ing options com­pen­sa­tion could have influ­enced the sub­se­quent deci­sion-mak­ing of CEOs in a way that was less than help­ful; it seems that it also did not accom­plish the orig­i­nal goal of the pub­lic, which was by most accounts the reduc­tion of the wage gap.

While options were the focus of the most scruti­ny and sub­se­quent changes, they were not the only kind of CEO pay trans­formed dur­ing the peri­od stud­ied. In 2008 options gave way to bonus­es as the most exco­ri­at­ed type of com­pen­sa­tion. From 2008 to 2009 the type of com­pen­sa­tion that dropped the most was bonus­es. So depend­ing on what the pub­lic is focused on, we see firms react by dimin­ish­ing that type of pay,” Kuh­nen says.

With a grind­ing finan­cial cri­sis threat­en­ing to turn into a glob­al reces­sion, as well as all the atten­tion on the Occu­py move­ment, we are liv­ing through a time when peo­ple are more focused on income inequal­i­ty than ever. Kuh­nen says that if the pro­tes­tors of Occu­py Wall Street were to focus on exec­u­tive pay rather than income inequal­i­ty in gen­er­al, she thinks that firms would react.

Whether or not that would be a good thing, how­ev­er, depends on your per­spec­tive. In a nor­mal econ­o­my, no one knows how to shape com­pen­sa­tion in a firm bet­ter than the peo­ple who work for it, and as Kuhnen’s research reveals, pub­lic pres­sure has in the past had the para­dox­i­cal effect of mak­ing CEOs some­what less account­able, at least in terms of their compensation.

It’s a com­pli­cat­ed issue,” Kuh­nen says. It’s not as sim­ple as, The pub­lic is a won­der­ful gov­ern­ing mech­a­nism and will help all firms do better.’ ”

Relat­ed read­ing on Kel­logg Insight

Hir­ing and Fir­ing at the Top: Indus­try con­di­tions mat­ter when look­ing to hire or fire a CEO

Today’s Ris­ing One-per­centers: The grow­ing gap between the very rich and everyone

Cor­ner Office Com­pen­sa­tion: Post-employ­ment ben­e­fits explain CEO compensation

Featured Faculty

Camelia Kuhnen

Faculty member in the Finance Department until 2013.

About the Writer

Christopher Mims is a journalist based in Washington, DC.

About the Research

Kuhnen, Camelia M. and Alexandra Niessen. 2012. “Public Opinion and Executive Compensation.” Management Science, 58(7): 1249-1272.

Read the original

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