Company boards are often faced with the task of determining CEO compensation based on incomplete information regarding their performance and competency. A study of US S&P 500 companies over a 7-year period examined the relationship between CEOs’ use of language that signals their competency and CEO compensation. The findings of this study indicated that the use of such language by CEOs was related to higher levels for CEO compensation, and this relationship was stronger when CEOs were under threat from shareholder activism.
Key Topics: CEO compensation; CEO performance; Symbolic language; Shareholder letters, Shareholder value principle
Title of Reviewed Article: Pay For Talk: How The Use Of Shareholder-Value Language Affects CEO Compensation
Researchers: Taekjin Shin (San Diego State University) and Jihae You (Louisiana Stata University).
Publication: Journal of Management Studies, 2017, Vol. 54 No. 1, pp. 88 - 117.
Setting the Scene
When it comes to determining CEO compensation, various factors are taken into account, such as experience, performance, and tenure, however, the evaluation process which boards of directors go through in order to determine CEO compensation is ultimately a largely subjective process, based to some extent on incomplete information and uncertainties (Graffin, Boivie, & Carpenter, 2013). As such, symbolic, socio-political, and psychological influences can become a part of assessing CEO performance and compensation (Bebchuk & Fried, 2004; O’Reilly & Main, 2010).
Prior studies indicate that, in determining CEO compensation, boards are influenced by symbolic actions which signal the CEOs alignment to desirable norms and expectations (e.g. Yeung, Lo, & Cheng, 2011), and may therefore be influenced by the contents of communications from CEOs, and the language they use.
Adherence by CEOs to the shareholder value principle, whereby publicly traded companies are run primarily to maximize shareholder value (Sundaram & Inkpen, 2004), is one indication that directors are likely to examine when assessing CEO compensation. The letters of CEOs to shareholders, published in the annual company accounts, are one method of communication that is attributed to CEOs and taken to reflect their views (Abrahamson & Hambrick, 1997), and the current study examines the role of shareholder-value–oriented language in these letters and its impact on CEO compensation.
It has been suggested that the need for boards to take account of symbols is due to a need to establish the legitimacy of their CEO (Suchman, 1995). As such, when the legitimacy of CEOs’ leadership is threatened there may be a heighted need for CEOs to display institutionally legitimized symbols. Such threats can come from shareholder activism against management, in the form of shareholder resolutions, which are proposals submitted by shareholders for a vote at the company's annual meeting, and are generally resolutions opposing management.
The following hypotheses were examined through this study:
Hypothesis 1 – “The expression of shareholder value orientation is positively related to the
level of CEO compensation.”
Hypothesis 2- “The effect of the expression of shareholder value orientation on the level of
CEO compensation is stronger when the firm receives a greater number of shareholder
resolutions than when it receives a smaller number of shareholder resolutions.”
How the research was conducted
This study developed a model to examine CEOs’ use of shareholder-value language and its relationship to their compensation by using data from 334 US S&P 500 listed companies between 1998 and 2005.
Information relating to CEO total compensation and other characteristics was taken from ExecuComp.
Company financial and operational data was sourced primarily from Compustat and supplementary sources.
Shareholder resolutions and voting information was sourced from Georgeson Inc., while board composition data was sourced from RiskMetrics and company proxy statements.
The expression of CEOs’ shareholder value orientation was assessed through the examination of the letters to shareholders published in company annual reports. Using the text search software application, dtSearch, the researchers analysed the letters to identify references to shareholder value. A manual review of a proportion of the letters was also carried out to ensure the validity of the dtSearch analysis.
As a moderating variable, shareholder activism was examined based on the volume of shareholder resolutions submitted for voting at the annual shareholder meetings.
A number of control variable, that could potentially affect CEO compensation were also assessed, including: company performance, company competitiveness, company size, CEO duality (i.e. if they are also the chairperson), board composition, and CEO tenure.
Key Research Findings
On average, reference to shareholder value was made 0.7 times per 1000 words and there were 1.3 references to shareholder value per letter.
The results provided support for Hypothesis 1 as a positive relationship was found between the expression of shareholder value and the level of CEO compensation. Furthermore, analysis indicated that for each additional reference to shareholder value per 1,000 words, this translated to an increase of $116,000 in average annual CEO compensation.
Support was also found for Hypothesis 2, with the number of shareholder resolutions moderating the relationship between the expression of shareholder value and the level of CEO compensation.
The researchers also examined the control variables to understand if these factors impacted on the relationship between the expression of shareholder value and the level of CEO compensation. The control variables were not found to have a significant impact on the relationship.
The results of this study demonstrate that greater symbolic expression of shareholder value by CEOs, through language used in letters to shareholders, is related to greater levels of CEO compensation. This finding indicates that boards view use of shareholder-value language by CEOs as a sign of CEO competence, and as a result grant greater levels of compensation.
As expected, shareholder activism had a moderating role in the effect of the expression of shareholder value orientation on the level of CEO compensation, with the effect being stronger as the number of shareholder resolutions increased. These results highlight the importance of CEO legitimacy when under attack, and indicate that being the subject of shareholder activism increases the effect of the shareholder-value language in the determination of CEO compensation, with boards seemingly placing greater importance on symbols as a sign of conformity to the shareholder value principle.
Organizational and Reward Implications
This study highlights the importance of symbols and language in the determination of CEO compensation, which is consistent with prior research on more formal symbolic practices, such as stock repurchasing and the adoption of popular management practices (Yeung et al., 2011), which also signal conformity to the shareholder value principle.
From a practical perspective, this study should provide food for thought for CEOs, their boards of directors, as well as shareholders. The study results indicate that the language CEOs use can have a significant bearing on their compensation determination, as it can play on the psychological biases of board members. With this in mind, boards and shareholders should be vigilant in their assessment of CEOs’ competency and apply robust measures to ensure that they can establish their CEOs actual performance and competency levels.
This study provides a unique insight into the relationship between the use of language by CEOs and their compensation determination. While this study focuses on a specific type of language use, the results do suggest that we might expect to see a similar relationship between CEO compensation and other communication types. It is hoped that further studies examine a broader array of CEO symbolic language and actions and how they relate to CEO compensation levels.
Source Article: Shin, T., & You, J. (2017). Pay for Talk: How the Use of Shareholder-Value Language Affects CEO Compensation. Journal of Management Studies, 54(1), 88–117.
Published by: John Wiley & Sons, Inc.
For further details and access to the full journal article Click Here (subscription or payment may be required).
Abrahamson, E., & Hambrick, D. C. (1997). Attentional homogeneity in industries: The effect of discretion. Journal of Organizational Behavior, 18(S1), 513-532.
Bebchuk, L., & Fried, J. M. (2004). Pay without performance: The unfulfilled promise of executive compensation. Cambridge, MA: Harvard University Press.
Graffin, S. D., Boivie, S. & Carpenter, M. A. (2013). Examining CEO succession and the role of heuristics in early-stage CEO evaluation. Strategic Management Journal, 34(4), 383-403.
O’Reilly, C. A., & Main, B. G. (2010). Economic and psychological perspectives on CEO compensation: A review and synthesis. Industrial and Corporate Change, 19(3), 675-712.
Suchman, M. C. (1995). Managing legitimacy: Strategic and institutional approaches. Academy of Management Review, 20(3), 571-610.
Sundaram, A. K. & Inkpen, A. C. (2004). The corporate objective revisited. Organization Science, 15(3), 350-363.
Yeung, A. C., Lo, C. K., & Cheng, T. C. (2011). Behind the iron cage: An institutional perspective on ISO 9000 adoption and CEO compensation. Organization Science, 22(6), 1600-1612.
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