Academic journal article Journal of Managerial Issues

Social, Political, and Economic Determinants of Chief Executive Compensation

Academic journal article Journal of Managerial Issues

Social, Political, and Economic Determinants of Chief Executive Compensation

Article excerpt

For more than a decade, as pressures for managerial accountability have increased, researchers in a variety of disciplines have studied questions associated with the compensation of top level corporate executives. The battle between corporate reformers who would curb chief executive compensation levels and those who believe that current levels of executive pay are appropriate has been intense. In fact, the battle has expanded beyond simple issues of compensation to include discussions of the mechanisms that exist to oversee and control corporate executives including the role and functioning of the board of directors (Kerr and Bettis, 1987; Colvin, 1992; Stewart, 1993).

While disagreement still exists on the exact role and responsibilities of the board, it is widely accepted that the board is the formal representative of a firm's shareholders. The board exists to monitor and reward top management while protecting the rights and interests of shareholders (American Law Institute, 1982; Hoskisson and Turk, 1990; Kosnik, 1990; Kosnik, 1987; Lorsch, 1989; Mace, 1971; Mallette and Fowler, 1992; Vance, 1983). However, corporate governance critics allege that boards are unwilling or unable to challenge or constrain management (Townsend, 1984). Too many directors act as part of management rather than as monitors of management activity who are able and willing to penalize management for poor performance (Patton, 1985; Vance, 1983). Boards have been accused of granting automatic pay increases to CEOs regardless of their performance (Geneen, 1984) and of enhancing their personal well-being at the expense of the company's shareholders (Colvin, 1992; Muckley, 1984; Vance, 1983). We agree with Kerr and Bettis (1987) that the compensation decisions of boards can be viewed as a surrogate test of their governing effectiveness. When CEO compensation fails to correlate with performance, boards can be viewed as forsaking their obligations to shareholders or, at the very least, failing to use compensation as a mechanism of control.

Researchers have sought to determine the correlates, or causes, of the variation that exists in executive compensation from one company to another. Previous studies have identified several rational/economic determinants of executive compensation. These studies have examined factors such as firm size (Ciscel and Carroll, 1980; Fox, 1983; Gomez-Mejia et al., 1987; Lewellen and Huntsman, 1970: O'Reilly et al., 1988), company performance (Baker et al., 1988; Finkelstein and Hambrick, 1989; Kerr and Bettis, 1987; Jensen and Murphy, 1990; Murphy, 1985), and company diversification (Berg, 1969; Finkelstein and Hambrick, 1989; Kerr, 1985; Lorsch and Allen, 1973; Napier and Smith, 1987: Pitts, 1974). Of these economic variables, only size has consistently predicted CEO remuneration.

Although organization theorists have long recognized that political processes can influence organizational action (Pfeffer, 1981; Thompson, 1967), the relationships between social and political forces and CEO compensation have not been examined fully in previous research. Of the studies incorporating behavioral variables, most have concentrated on linkages between executive pay and relatively apolitical factors. The development and testing of human capital models (Becker, 1964; Mincer, 1970) represents one research thrust. These models rely on personal attributes like age, experience, education (Deckop, 1988, Finkelstein and Hambrick, 1989; Foster, 1980), and level in the management hierarchy (Lawler and Porter, 1966; Mahoney, 1979; Rajagopalan and Prescott, 1990) to help explain compensation variation. Findings are clearly mixed, with human capital variables often explaining little or no variation in executive pay. Such factors as organizational power and politics, board member attributes and social processes, and group phenomena have not been subjected to similar scrutiny. But, the effect of social and political factors are becoming more apparent as boards of directors have more openly acknowledged the influence that CEOs exert over compensation decisions. …

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