This post confirms three things at once
This post is simultaneously part 4112 in my long-running series on “the unintended consequences of regulation”, part 276 in my series on “benchmarking is stupid”, and part 75 in my series on “CEOs are smart and exploit the system”. So, consider yourself lucky you get three posts in one.
Shawn Mobbs from the University of Alabama reached out to me about a paper he and his colleagues published recently. In it, they investigate how the 2006 regulation by the SEC that introduced CEO compensation benchmarking managed to curb the rise of CEO pay. Spoiler alert: it didn’t.
The regulation required publicly listed companies to benchmark the compensation package of their CEOs against the compensation of CEOs at peers. In the spirit of “sunlight is the best disinfectant” the rule aimed to curb the excessive pay packages some executives got. But sunlight is not just a disinfectant, it is also a source of energy for further growth. And this is what happened in this case. By forcing companies to disclose the compensation of peers, the CEOs of these companies (and their peers) could easily see if they made more or less money than them.
And I guess this created some awkward discussions in the boardroom of some companies because what Shawn’s research shows is that CEOs of companies that are more often cited by their peers as a benchmark have a higher likelihood of changing jobs afterward. Even if they do not change jobs, they are still likely to get a higher compensation package. And not just a little higher. Being cited by seven more firms as a peer group CEO increases the CEO compensation for a CEO who doesn’t change jobs by roughly $500,000.
And what if the board wasn’t willing to increase the compensation of these CEOs that are more often cited in the peer group benchmark of other firms? Well, they just left for a better job. CEOs in the top quartile most-cited companies had a likelihood of 9.8% of leaving the following fiscal year, while CEOs in the bottom quartile had a likelihood of 7% of leaving.
Thus, the introduction of this regulation and the forced benchmarking of CEOs led to an acceleration of CEO compensation.
CEO to worker compensation ratio in the US 1965-2019
Source: Economic Policy Institute