The CEO Share of Earnings: A New Approach to Evaluating Executive Compensation

Business Economics, April 2009 | Go to article overview

The CEO Share of Earnings: A New Approach to Evaluating Executive Compensation


The CEO Share Of Earnings: A New Approach To Evaluating Executive Compensation

Kevin M. Zhao, Charles L. Baum and William F. Ford are on the faculty of the Department of Economics and Finance. Middle Tennessee State University.

Business Economics (2009) 44, 120-122.

doi:10.1057/be.2009.9

The recent spate of failures among both financial and non-financial companies has been accompanied by a growing interest in and concern about the compensation of the CEOs of major U.S. corporations. This, in turn, has reignited interest among both academics and financial practitioners about agency theory issues, especially the question of whether or not the total compensation of CEOs is properly scaled in relation to the earnings they generate for the shareholders they serve. This study adds to the current literature on CEO compensation by introducing a new metric, the CEO Share of Earnings (CEOSE). It explores secular trends in the CEO'S total compensation per dollar of earnings among profitable S&P 500 companies.

Our null hypothesis, consistent with the popular assumption in the media, is that the secular growth of CEO compensation has become increasingly misaligned with the earnings results that CEOs have produced for shareholders. Surprisingly, our initial findings, drawing on secular trends among S&P 500 firms, appear to show that our hypothesis does not hold, and that, over an extended period of time, CEOs have not received compensation that is out of line with the their companies' earnings trends.

During 2008, the first full year of the current recession, both the financial and non-financial media have been full of stories asserting that corporate CEOs and other executives are paid too much. The question this raises is: Compared to what? The academic literature on agency theory posits that the total compensation of non-owner mangers of publicly held companies should, over time, be aligned with and driven by the returns that they generate for the shareholders they serve. In this preliminary phase of our work, we use the CEO share of earnings--a new pay-to-performance metric--to track CEO total compensation compared to the earnings of shareholders over a 15-year period. In later phases. we will also explore the relationship between CEO compensation and other total return measures, which will include returns in the form of capital gains and dividends per share generated by the corporation for its owners.

The data we use to compare secular trends in the CEO share of earnings covers a period from 1993 to 2007. It combines information on CEO compensation from EXECUCOMP with accounting data from COMPUSTAT and stock prices and returns information from the Center for Research in Security Prices (CRSP). We chose to focus on a large subset of S&P 500 firms for which compensation data are available each year from 1993 to 2007. We have purposely omitted companies that experienced losses during our sample period, a subset of S&P 500 firms that will Reanalyzed separately in a later phase of our work on the CEO share of earnings. We omitted loss-making companies because earnings must be positive for our metric to be measured as a percent of corporate profits.

In Table 1, we provide compensation and other data for 2007 on the 393 S&P 500 companies that were in our sample that year. (1) The CEOs of those companies ranged in age from 38 to 83 years old. Their companies, on average, had total assets of over $65 billion, about 55,000 employees, and a year-end 2007 market value of just under $30 billion. The average CEO owned well under one percent of the company's shares and received

Table 1. 2007 Summary Statistics

Variables           Mean        Median   Standard  Minimum   Maximum
                                         Deviation

Age of CEO             56         56       0.34       38             83

Number of          55,234     26,900      6,328      243      2,100,000
employee

Tolal assets       65,664     15,562     10,040      841      2,187,631
($ million)

Equity market      29,850     14,111      2,508      744        511,887
value($
million)

% of Shares        0,698%      0,118%      0,144%  0. … 

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