Corporate governance and chief executive ofcer compensation

Steven T. Petra and Nina T. Dorata

Steven T. Petra is based at the Frank G. Zarb School of Business, Hofstra University, Hempstead, NY, USA. Nina T. Dorata is based at the Peter J. Tobin College of Business, Department of Accounting and Taxation, St Johns University, Queens, NY, USA.

Abstract Purpose This paper aims to examine whether there is an association between the level of performance-based incentives offered to CEOs and the composition of rms boards of directors and the compensation committee. Design/methodology/approach Univariate tests are used to test the relation between the level of performance-based incentives and corporate governance structures. A logistic regression analysis is used to predict the probability of CEOs receiving low performance-based incentives when various characteristics of rms boards of directors and compensation committees exist. Findings The authors nd the presence of CEO duality reduces the likelihood of lower levels of performance-based incentives offered to CEOs. Additionally, the authors nd CEOs are more likely to receive lower levels of performance-based incentives when the majority of the compensation committee members serve on less than three other boards, and when the size of the board is less than or equal to nine members. Research limitations/implications This study is limited by the fact that the sample may not be representative of the general population of companies in the US. Practical implications Shareholders who desire to keep CEO compensation levels low may consider supporting the separation of the positions of CEO and Chairperson of the Board, as well as supporting limiting the number of other boards directors may serve, and reducing or keeping the size of the board to a maximum of nine members. Originality/value The authors have documented an association between board structure and CEO compensation. It appears that company boards are able to monitor and control the compensation level offered to CEOs. Keywords Corporate governance, Compensation, Boards of directors Paper type Research paper

Introduction
The well-publicized collapses of large publicly traded companies have incited much controversy over the failures of corporate governance structures to properly protect investors. Perhaps the most blatant example of corporate governance failure and the one that has caused the most public disdain involves that of executive compensation. Core et al. (1999) nds evidence that suggests CEOs earn greater compensation when governance structures are less effective. Executive compensation levels have skyrocketed to the point where the ratio of CEO compensation to average employee wages for large rms increased from 44:1 in 1965 to 301:1 in 2003. Compensation levels resulted in such a hue and cry from the general public that the US Congress placed a ceiling of one million dollars on the deductibility of executive compensation[1]. Hall and Murphy (2003) report that performance-based incentives such as stock options account for the lions share of CEO compensation. It is plausible and perhaps probable that stock options and other

Received January 2007 Revised February 2007 Accepted February 2007 The research contained in this paper was supported by a summer research grant from the Frank G. Zarb School of Business at Hofstra University.

DOI 10.1108/14720700810863779

VOL. 8 NO. 2 2008, pp. 141-152, Q Emerald Group Publishing Limited, ISSN 1472-0701

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equity-based incentives offered CEOs shifted CEOs focus from managing their rms protability to managing their rms stock price. Such a shift may not be supportive of a rms ability to plan and execute a long-term strategy for the benet of the rms long-term shareowners. The collapse of Enron Corp. at the end of 2001 resulted in such a public outcry that the US Congress drafted, and on July 30, 2002, President Bush signed into law, the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). Sarbanes-Oxley contains many reforms intended to protect investors by raising corporate governance standards designed to improve the accuracy and reliability of corporate disclosures. Section 304 of Sarbanes-Oxley requires the CEO (and CFO) to reimburse the company for any bonus or other incentive-based or equity-based compensation received and any prots realized from the sale of company securities during the 12-month period following the issuance of misleading nancial statements that were required to be restated as a result of misconduct. Additionally, in 2003 the Securities and Exchange Commission approved reforms to the corporate governance requirements of the New York Stock Exchange, the National Association of Securities Dealers, and the American Stock Exchange. The exchange reforms are intended to raise corporate governance standards and enhance the accountability, integrity, and transparency of rms disclosures to shareholders. The purpose of this paper is to examine whether there is an association between the level of performance-based incentives offered to CEOs and the composition of rms boards of directors and the compensation committee. We nd that the presence of CEO duality (boards of directors that are chaired by the rms CEO), the number of other boards served by the rms board members, and the size of the rms board are signicantly associated with the performance-based incentives offered to CEOs. In particular, we nd that the presence of CEO duality reduces the likelihood of lower levels of performance-based incentives offered to CEOs. Additionally, we nd that CEOs are more likely to receive lower levels of performance-based incentives when the majority of the compensation committee members serve on less than three other boards, and when the size of the board is less than or equal to nine members. Pay for performance Firms today are characterized by the separation of ownership (i.e. shareholders) and control (i.e. management). Under agency theory, the separation of ownership and control leads to agency costs (assuming that both parties to the agency relationship are utility maximizers) which many rms have attempted to reduce by basing management compensation on rm performance. Shareholders can use performance results, such as net income and market valuation, to determine the amount of effort extended by management and adjust managements compensation appropriately (e.g. increased (decreased) rm performance will result in increased (decreased) compensation). In this way, shareholders hope to better align managements interests with their own. However, in many instances such as Enron Corp., WorldCom, Inc., Global Crossing, Inc., and others, top management, including the CEO continued to receive large compensation packages despite the failure of their companies. Clearly the link connecting executive compensation and rm performance is stretched very thin if not broken altogether. The use of equity-based compensation (e.g. stock options and restricted stock) continues to be the favored paradigm for making pay more sensitive to performance. Coffee (2003) reports, CEO equity-based compensation rose from ve percent to around sixty percent of their total compensation during the years 1990 to 1999. Equity-based compensation has the intuitive appeal of aligning management and shareholder interests. Management pay increases and shareholder wealth increases concurrently with increases in the value of company stock. Unfortunately, increases (as well as decreases) in the value of a companys stock does not necessarily correlate with the amount of effort extended by management. It is well understood that industry and general market trends have a profound impact on stock price movement and these are unrelated to management performance. A study of US stock prices reported that only 30 percent of share price movement reects corporate

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performance, the remaining 70 percent reects general market conditions[2]. By failing to lter out stock price movements that are unrelated to management performance many equity-based compensation plans have decoupled pay from performance. The key compensation goals of many rms are to hire, motivate, reward, and retain CEOs who create long-term investor value. CEO compensation packages therefore contain elements designed to satisfy the expectations of the CEO while at the same time provide incentives designed to satisfy the expectations of the shareholders. Mehran (1995) found evidence indicating that the form rather than the level of compensation is what motivates managers to increase rm value. The emergence of pay-for-performance packages arose out of the belief that the manner in which CEOs are paid directly impacts rm performance. Although this belief is certainly debatable, it is clear that variable pay (i.e. pay-for-performance) is often a powerful driver of behavior. CEO compensation packages often contain performance targets designed to motivate the CEO to make decisions that will grow the company towards the desired target. Often times the performance target is attaining a specied level of growth in the companys stock price. This can place the CEO in the undesirable position of focusing on short-term market value changes leading to decisions that focus on near-term objectives at the expense of the companys long-term strategic plan. Organizations such as the Business Roundtable advocate that performance-based incentives should not be tied solely to the corporations stock. Indeed, the bursting of the dot-com bubble at the turn of the century is testimony to the dangers of focusing on stock price movement and overlooking rms operating results. The investment landscape is littered with the bodies of beleaguered investors who lost their retirement nest egg while the CEOs of those companies received record-breaking compensation. The board of directors and the compensation committee CEOs have varying degrees of inuence over the board. Evidence indicates that CEOs pay increases as their inuence over the board increases. Many rms have the role of chairperson of the board lled by their CEO. This duality of positions (i.e. the CEO also serving as chairperson of the board) places the CEO in a powerful position of managing the operations of the rm and also overseeing the direction the rm will take into the future. As chairperson, the CEO is responsible for running the board meetings, setting agendas and overseeing the processes of hiring, ring, and compensating top management. Core et al. (1999) nd that CEO compensation is higher when the CEO is also the board chair. In addition to CEO duality, inuence over the board by the CEO increases as the size of the board increases. This can be due to a myriad of reasons, not the least of which is that large boards require more members to join together as a majority to challenge the CEO than small boards. Core et al. (1999) nd that CEO compensation is higher when the size of the board is larger. Additionally, Yermack (1996) nds that as board size increases pay-for-performance sensitivity decreases. Many boards utilize committees, such as the compensation committee to assist the board in fullling its duties and responsibilities to the shareholders. The responsibility of the compensation committee is to evaluate and recommend the compensation of the rms top executive ofcers including the CEO. Boyd (1994), and Cyert et al. (1997) nd that strong compensation committees are better able to keep CEO compensation under control. The New York Stock Exchange, the National Association of Securities Dealers, and the American Stock Exchange have adopted new corporate governance regulations requiring listed companies to maintain compensation committees composed entirely of individuals who are independent of management in the belief that outside independent directors are better able to fulll their responsibilities objectively and strengthen compensation committees. Klein (2002), found evidence that suggests that boards structured to be more independent of the CEO are more effective in monitoring management decisions. On the other hand, Anderson and Bizjak (2003), found that CEOs serving on the compensation committee did not act opportunistically in terms of pay structure.

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In addition to committee independence, other characteristics of the compensation committee also impact the committees ability to objectively evaluate and recommend the compensation level for the rms CEO. Clearly, the length of time serving on the companys board plays an important role in a directors ability to digest all of the information made available concerning the operations of the rm. Studies conducted by Lorsch and Palepu (2003) provide evidence that independent directors devote very little time serving on company boards. It stands to reason therefore that board members will need several years to build a solid foundation of knowledge upon which to analyze and interpret the myriad of company documents that they are provided. However, long-tenured directors may indicate an unwillingness to confront the CEO on the executive compensation package being tendered. Main et al. (1995) indicate that directors, who cannot continue to support a CEO who has the support of the rest of the board, are expected to resign. One could reasonably conclude that long-tenured directors have a history of supporting the CEO. On the other hand, recently-tenured directors may lack the experience necessary to fully comprehend the implications of their decisions and/or may be easily swayed by long-tenured directors. Additionally, recently-tenured directors may begin serving on the board with a sense of friendship and loyalty to the CEO. Shivdasani and Yermack (1999) nd that CEOs nominate individuals to sit on the board who will not be likely to question or disagree with the manner in which the company is managed. It is reasonable to believe that newly elected directors will not challenge the CEO regarding pay. Main et al. (1995) nd that compensation committees tend to award higher CEO compensation when the committee chair has been appointed after the CEO takes ofce. Accordingly, a properly operating compensation committee should contain a good balance between long and short-tenured directors. The Corporate Library has dened long and short-tenured directors as those serving on the board for more than fteen years and less than four years, respectively. Director age can be a factor inuencing operations of the compensation committee. It is undisputed that older directors have proven themselves to be valued, productive members who sit on the boards of many companies. However, organizations such as the National Association of Corporate Directors advocate mandatory retirement ages for directors. Many companies have established a mandatory retirement age of 70 for their directors. Compensation committees with a majority of older members may be an indication that the committee is stuck in a particular mindset that is unwilling or unable to adjust its mode of thinking to changes in the companys needs. Core et al. (1999) nd that CEO compensation increases as the percentage of outside directors over age 69 increases. Kole (1997) highlighted the fact that CEO compensation packages are often complicated documents that contain various compensation amounts for various performance targets. Such compensation amounts are usually structured to contain a base salary plus short-term (i.e. annual) incentives and long-term (i.e. beyond one year) incentives. Short-term incentives often take the form of an annual cash bonus while long-term incentives often take the form of stock options and/or restricted stock. Additionally, it is incumbent on the compensation committee to ensure that its CEO compensation package is competitive with industry practice so as to ensure the retention of a desired CEO. However, the complexity of compensation packages makes them difcult for board members to understand[3]. For these reasons, many rms employ the use of outside compensation consultants to aid in the formulation of a suitable compensation package for their CEO. It is imperative therefore that rms compensation committees be composed of individuals who have experience in evaluating and implementing CEO compensation packages and be knowledgeable of the maximum payout under such packages. Individuals such as retired CEOs or other executives who have negotiated compensation packages for themselves would be well suited to serve on compensation committees. However, active CEOs should not serve on rms compensation committees for fear of creating an interlocking relationship[4] and not objectively evaluating the compensation level for the rms CEO. Hallock (1997) nds that CEO pay is larger in companies with interlocking directors.

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In line with the fact just discussed that todays CEO compensation packages are very complicated and complex instruments, members of the compensation committee must be able to devote enough time to study and evaluate the package being recommended for compensation of the rms CEO. Therefore, members of the compensation committee must not be over-committed. Core et al. (1999) nd that CEO compensation increases with the number of outside directors serving on four or more boards.

Research design
Hypothesis development The hypothesis of this paper is that the composition of rms boards of directors and compensation committees induces optimal CEO contracting. Under this hypothesis, shareholders elect members to the board of directors who will choose a CEO compensation contract that species the level of compensation as a function of performance. The relationship between executive compensation and corporate governance has been analyzed and the results have been documented in the literature. In the majority of these studies, executive compensation has been represented by a continuous variable, measured by compensation levels expressed in terms of the natural log of the compensation (Anderson and Bizjak, 2003) or a percentage of performance-based pay to total pay (Yermack, 1995). These studies have reported mixed results in determining the association, (if any), between executive compensation and corporate governance structures. The present study also attempts to determine the association, (if any), between executive compensation and corporate governance structures. However, the dependent variable in the present study, performance-based pay, is measured qualitatively as to whether or not the pay level is below the median level of the sample and is expressed in terms of a binary variable with values of one or zero. Use of a binary dependent variable in the model allows for the separation of rms within the sample where such separation using a continuous variable may not be signicant. The board of directors is seen by shareholders as an institution for monitoring and controlling the actions of management in as much as the board has the authority to hire, re, and set compensation levels for top management. Shareholders expect that boards of directors will construct efcient compensation contracts that link pay with performance. However, Lublin (2003) reports that only 8.5 percent of large public rms issuing options to executives conditioned the grant on performance in 2002. The fact that such a large proportion of rms are issuing stock options that are not conditioned on performance supports the belief espoused by Bebchuk and Fried (2004) that executive compensation packages are the result of managerial power and not arms-length bargaining. Latham (1999) nds that boards of directors are often controlled by the rms CEO. Managerial power over rms boards of directors has resulted in compensation packages that only minimally condition pay on performance by establishing performance-based incentives that are tied solely to rms stock prices. Firms boards of directors are structured in many different ways to meet the needs of the organization. Variations between rms boards include but are not limited to: whether or not the CEO also serves as chair of the board (i.e. CEO duality); the size of the board; the number of years directors are permitted to serve on the board; the size of the compensation committee; the professional background (e.g. business, academic, and government) and the independence of the compensation committee members; the age of the compensation committee members; the proportion of the compensation committee members who are currently employed versus the proportion who are retired; the number of other boards members of the compensation committee are permitted to serve on, and whether or not active CEOs are permitted to serve on the compensation committee. Models Univariate tests are used to test the relation between the level of performance-based incentives and the test variables. A logistic regression analysis is used to predict the

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probability of CEOs receiving low performance-based incentives when various characteristics of rms boards of directors and compensation committees exist. The test variables chosen are identied in the literature and by the Corporate Library and the National Association of Corporate Directors as inuencing the dependent variable, CEO performance-based compensation. We measure each independent variable with a binary code of one or zero. A code of one (zero) is used to indicate, the existence (no existence) of a particular governance characteristic. Such coding allows us to determine whether or not each governance characteristic is important in reducing the level of CEO performance-based compensation. We do not include control variables in our analysis as the dependent variable, CEO performance-based compensation, is a function of the amount of such compensation contained in the sample. We are not measuring the level of CEO compensation independently by company, and therefore we do not need to control for other factors that have been shown to inuence compensation, such as rm size, rm performance, risk, and the investment opportunity set. The following full model is used: g PERFPAYLO t0 t1 DUAL t2 INDCC t3 YEARS t4 ABACK t5 BBACK t6 GBACK t7 AGE t8 RETIRE t9 COMMIT t10 CCCEO t11 BOARDSIZELO t12 COMPSIZELO The following reduced model is used: g PERFPAYLO b0 b1 DUAL b2 COMMIT b3 BOARDSIZELO 2 1

where the dependent variable is: PERFPAYLO the performance pay percentage of total CEO compensation is less than the sample median of 65 percent, 1 yes, 0 no. The test variables are:
B B

DUAL The chief executive ofce is also chairperson of the board, 1 yes, 0 no. INDCC The compensation committee is composed entirely of outside independent directors, 1 yes, 0 no. YEARS The members years on the compensation committee is from four to fteen, 1 yes, 0 no. ABACK The majority of compensation committee members have academic backgrounds, 1 yes, 0 no. BBACK The majority of compensation committee members have business backgrounds, 1 yes, 0 no. GBACK The majority of compensation committee members have government backgrounds, 1 yes, 0 no. AGE The age of the majority of compensation committee members is under 70, 1 yes, 0 no. RETIRE The majority of compensation committee members are retired, 1 yes, 0 no. COMMIT The majority of compensation committee members serve on less than three other boards, 1 yes, 0 no. CCCEO There are no active chief executive ofcers on the compensation committee, 1 yes, 0 no. BOARDSIZELO The size of the board is less than the sample median number of members of 9, 1 yes, 0 no. COMPSIZELO The size of the compensation committee is less than the sample median number of members of 3, 1 yes, 0 no.

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Sample selection and data collection The sample consists of 237 publicly traded US rms, 55 percent are listed on the NYSE, 43 percent are listed on NASDAQ, and 2 percent are listed on the AMEX[5]. The rms were selected at random from the database maintained by the Corporate Library. To be included in the sample, these rms are required to have a compensation committee; have led a proxy statement in 2004 with the Securities and Exchange Commission; and be listed on a major stock exchange. Data on CEO performance-based incentives, the composition of the board of directors, and the composition of the compensation committee was collected from the proxy statements, led in 2004, contained in the EDGAR database of the Securities and Exchange Commission. We categorize directors according the Byrd and Hickman (1992). Independent directors are individuals whose only business relationship with the rm is their directorship. Insiders and gray directors are not considered independent. Directors employed by the rm, retired from the rm, or family members are insiders. Gray, (afliate), directors are directors with existing or potential business ties to the rm, but are not full-time employees. Examples of gray or afliated directors are the rms legal counsel, consultants, nanciers, and investment bankers.

Results
Sample description Table I provides descriptive statistics of CEO compensation. The mean total compensation is $6,023,000 of which 58 percent is performance-based. Univariate tests Univariate tests are presented in Table II. The proportion of the sample in which the CEO also holds the position of board chairperson (DUAL) is approximately 52 percent (n 124) and Table I Sample description
Mean Minimum Maximum Median SD

Descriptive statistics for CEO compensation ($000s) Base pay 648 Other compensation 131 Bonus 835 Options 3,509 Restricted stock 759 Other performance pay 175 Total performance pay 5,244 Total compensation 6,023 Performance pay percentage (%) 58

0 0 0 0 0 0 0 0 0

2,043 3,154 8,978 151,005 17,900 11,621 154,255 156,168 99

596 0 411 0 0 0 1,206 1,919 65

341 361 1,272 14,752 2,115 1,052 15,225 15,431 30

Notes: Total performance pay includes bonuses, options, restricted stock and other performance pay (e.g. cash payments under a long-term incentive program); Denition of variables: PERFPAYLO The performance pay percentage is less than the sample median of 65 percent, 1 yes, 0 no; DUAL The chief executive ofce is also chairperson of the board, 1 yes, 0 no; INDCC The compensation committee is composed entirely of outside independent directors, 1 yes, 0 no; YEARS The members years on the compensation committee is from 4 to 15, 1 yes, 0 no; ABACK The majority of compensation committee members have academic backgrounds, 1 yes, 0 no; BBACK The majority of compensation committee members have business backgrounds, 1 yes, 0 no; GBACK The majority of compensation committee members have government backgrounds, 1 yes, 0 no; AGE The age of the majority of compensation committee members is under 70, 1 yes, 0 no; RETIRE The majority of compensation committee members are retired, 1 yes, 0 no; COMMIT The majority of compensation committee members serve on less than three other boards, 1 yes, 0 no; CCCEO =There are no active chief executive ofcers on the compensation committee, 1 yes, 0 no; BOARDSIZELO The number of board members is less than the sample median number of members of 9, 1 yes, 0 no; COMPSIZELO The number of compensation committee members is less than the sample median number of members of 3, 1 yes, 0 no

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Table II Univariate tests

Independent variable DUAL NO DUAL Total INDCC NO INDCC Total YEARS NO YEARS Total ABACK NO ABACK Total BBACK NO BBACK Total GBACK NO GBACK Total AGE NO AGE Total RETIRE NO RETIRE Total COMMIT NO COMMIT Total CCCEO NO CCCEO Total BOARDSIZELO NO BOARDSIZELO Total COMPSIZELO NO COMPSIZELO Total Number of observations 124 113 237 173 64 237 120 117 237 3 234 237 228 9 237 1 236 237 202 35 237 45 192 237 173 64 237 107 130 237 82 155 237 133 104 237 Mean 7,780 2,470 3,800 9,140 3,830 6,700 3,480 5,270 5,370 1,980 5,360 5,240 5,680 2,720 4,430 5,430 3,920 8,830 3,510 6,670 2,510 6,690 3,810 7,080 Difference t-value

5,310

2.720**

2 5,340

2.420*

2 2,870

1.460

2 1,790

0.200

3,390

0.660

120

0.010

2,960

1.060

2 1,000

0.400

2 4,910

2.220*

2 3,160

1.600

2 4,180

2.020*

2 3,270

1.650

Notes: Dependent variable: total performance pay ($000s); *, **Signicant at the 0.05 and 0.01 levels, respectively; The dependent variable, total performance pay represents the sum of bonus, options, restricted stock, and other performance pay. See Table I for denitions of all other variables

has a mean pay for performance compensation of $7,780,000. The mean pay for performance compensation for the portion of the sample when there is no duality (n 113) is $2,470,000. Univariate tests show that the difference in the means for these two groups is signicant at the 0.01 level. The fully independent compensation committee group, (INDCC), (n 173) has lower pay for performance compensation of $3,800,000 compared to the no INDCC group (n 64) of $9,140,000 at the 0.05 level[6]. Signicant differences are also found when the majority of compensation committee members serve on less than three other boards, (COMMIT), (n 173), with a mean pay for performance compensation of $3,920,000 compared to the no COMMIT group (n 64) of $8,830,000 at the 0.05 level. These results support the ndings that CEO duality produces higher performance-based compensation levels; whereas, independent compensation committees and board members who are committed to serve on fewer than three other boards produce lower performance-based compensation levels. Boards whose size was less than the sample median of nine members (BOARDSIZELO) (n 82) had a lower mean pay for performance compensation of $2,510,000 compared to $6,690,000 to the sample of boards whose size was greater than the sample median size (n 155). The difference in these means was signicant at the 0.05 level.

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Multivariate results The results of the logistic regressions appear in Table III. In both the full and reduced models, DUAL, COMMIT, and BOARDSIZELO are signicant factors that affect the likelihood of CEOs receiving low pay for performance compensation levels. Specically, the full and reduced models show that, on the average, the probability of receiving low pay for performance compensation levels is 11.5 percent lower, which is signicant at the 0.10 level, and 13.4 percent lower, which is signicant at the 0.05 level, respectively, if the CEO is also the chairperson of the board (DUAL). Conversely, the probability of receiving low pay for performance compensation levels is, for both models, approximately 13 percent greater, which is signicant at the 0.10 level, when the majority of compensation committee members

Table III Logistic regression results

(n 237) Intercept DUAL Full model 2 0.992 1.068 2 0.460 (2.709)* {0.115} 0.048 (0.022) {0.012} 0.114 (0.168) {0.028} 2 0.508 (0.141) {0.127} 0.452 (0.315) {0.113} 2 14.408 (0.000) {3.601} 2 0.180 (0.196) {0.045} 2 0.416 (1.293) {0.104} 0.509 (2.640)* {0.127} 0.297 (1.077) {0.074} 0.831 (7.474)*** {0.208} 0.274 (0.850) {0.069} 305.237 0.025 0.164 Reduced model 2 0.402 (1.760) 2 0.535 (3.898)** {0.134} 0.504 (2.725)* {0.126} 0.897 (9.777)*** {0.224} 311.042 0.001 0.155

INDCC

YEARS

ABACK

BBACK

GBACK

AGE

RETIRE

COMMIT

CCCEO

BOARDSIZELO

COMPSIZELO

2 2 Log-Likelihood P-value Pseudo R2

Notes: Dependent Variable-PERFPAYLO; Asymptotic t-statistics are in parentheses. Predicted probabilities are in brackets when the independent variable equals one while all other independent variables are held constant to zero. Probabilities are determined by b1. . .13pi (12 pi), where b are the estimated coefcients from the logistic regressions and p is the proportion of the sample when the dependent variable is equal to one; see Table I for denition of variables. *, **, ***Signicant at the 0.10, 0.05, and 0.01 levels, respectively Source: Allison (2003)

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serve on less than three other boards (COMMIT). A smaller board size (BOARDSIZELO) increases the probability of low pay for performance compensation levels by 21 percent and 22 percent in the full and reduced models, respectively, which are signicant at the 0.01 level. These ndings are consistent with Core et al. (1999), and Yermack (1996). In the full model, a fully independent compensation committee (INDCC), board tenure (YEARS), business experience (BBACK), inactive CEO membership (CCCEO), and smaller compensation committees (COMPSIZELO) increase the likelihood of CEOs receiving low pay for performance compensation levels, however, these factors are not signicant. Academic (ABACK), and government (GBACK) experience, board member age (AGE), and board members who are otherwise retired (RETIRE) are insignicant factors that decrease the likelihood of receiving low pay for performance compensation levels.

Summary and conclusion

Our results are consistent with some of the guidelines for improving corporate governance that are promulgated by groups such as the National Association of Corporate Directors. In particular, calls for improving corporate governance by separating the positions of Chairperson and CEO, relying on small boards, and limiting the number of other boards on which a board member may serve are all consistent with our results. However, contrary to many guidelines for improving corporate governance, we nd no evidence that independent outside directors, board tenure, type of board member experience, mandatory retirement of board members before reaching age 70, having a majority of compensation committee members who are retired, and prohibiting active CEOs from serving on compensation committees, result in improved governance systems. This study makes an important contribution to the corporate governance literature. We have documented an association between board structure and CEO compensation. We nd that companies that place the CEO in the position of chairperson of the board are less likely to keep CEO performance-based compensation levels low. We also nd that the likelihood of keeping CEO performance-based compensation levels low is increased in companies that limit their board members to serving on less than three other boards, and in companies that keep the size of their board to less than ten members. It appears that company boards are able to monitor and control the compensation level offered to CEOs. Shareholders who desire to keep CEO compensation levels low may consider supporting the separation of the positions of CEO and Chairperson of the Board, as well as, supporting limiting the number of other boards directors may serve, and reducing or keeping the size of the board to a maximum of nine members. This study is limited by the fact that our sample may not be representative of the general population of companies in the US. The companies in our sample were chosen at random and reect a broad representation of many industries. Future research may focus on industry specic relationships between boards of directors and CEO compensation. It would be interesting to determine if the relationship between corporate governance and chief executive ofcer compensation is sensitive to the industry in which rms operate.

Notes
1. See Internal Revenue Code section 162 (m). 2. The study by SCA Consulting is reported in Simon Patterson and Peter Smith, How to make top peoples pay reect performance, Sunday Times (London), August 9, 1998, business section, 12. 3. Patrick McGeehan, Quick: whats the boss making? New York Times, September 21, 2003, sec. 3, 1. 4. An interlocking relationship exists when the CEO of rm A serves on the compensation committee of rm B and the CEO of rm B serves on the compensation committee of rm A. In this way, both CEOs can agree to support preferential compensation packages for each other. 5. The collection of rms governance structure data is extremely time consuming. It was decided to limit the number of rms included in the sample so as to allow for a reasonable time period for completion of this study.

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6. These results can be compared to Anderson and Bizjak (2003) who nd little evidence that greater compensation committee independence affects executive pay. Anderson and Bizjak used the fraction of outside directors on the compensation committee as their independent variable. When using fully independent compensation committees as their independent variable, results are marginally signicant in support of greater use of performance-based pay.

References
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About the authors

Steven T. Petra is an Associate Professor at the Frank G. Zarb School of Business at Hofstra University in New York. He holds a PhD degree in accounting and is a Certied Public Accountant. His research interests include corporate governance and the role of boards of directors in improving public condence in corporate earnings numbers. Steven T. Petra is the corresponding author and can be contacted at: actstp@hofstra.edu Nina T. Dorata is an Assistant Professor at the Peter J. Tobin College of Business at St. Johns University in New York. She holds a PhD degree in accounting and is a Certied Public Accountant. Her research interests include business combination accounting and the inuence of executive compensation on bid premiums for mergers and acquisitions.

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