Executive Compensation Essay

Submitted By njf91
Words: 912
Pages: 4

Executive Compensation
United States compared with selected European Countries

Executive compensation is not only highly debated within the United States, however. It has drawn attention worldwide but the lack of international pay data has left many researchers with the United States as the most suitable testing ground for agency theory (Conyon & Schwalbach 1999). Generally studies conducted in one country alone due not yield strong empirical data because of the uniformity of institutional characteristics and similar pay practices. However, since the turn of the millennium European countries have began a phase of transparent pay disclosures due to tightened regulation and increase in investor demand. This new research using the largest 158 countries in 12 European nations has shed light on the debate over executive compensation and the optimal structure of company management and the board of directors across various corporate governance landscapes to yield better empirical results about whether executive pay is indeed out of control and board independence and pay regulation are needed.

In agency theory, there are two main hypotheses regarding executive compensation and their influence on the boards. Popular opinion suggests that most people are suspect of conflict of interest regarding pay when executive are also on the board and especially when CEOs serve as the chairman of the board. Such overlap is common due to the known enhanced communication between the board and management (Fama & Jensen 1983), especially in times of uncertainty (Burkart & Gromb 1997). The opportunism hypothesis which supposes that executives extract rents through their pay contracts and further predicts that companies with more executives on the board leads to less transparency about their pay and hence a lessening of shareholder value. On the other hand, the contracting hypothesis holds that pay contracts maximize shareholder value and further predicts that firms with executives on their boards make more transparent disclosures to prove to the outsiders that they are not extracting too much money from the company. At first glance, the opportunism hypothesis seems more intuitive. However, this is not what the research indicates. It has been found that in companies with more executives on their boards, also known as insiders, and CEOs serving as board chairs, there are more transparent executive pay disclosures and the pay is more sensitive to performance (Muslu 2010). Both of these key findings support the contracting hypothesis, contrary to popular opinion on the matter. It must be noted that this holds true in countries that have institutions for investor protection so that opportunistic behavior of entrenched or majority insider boards cannot manifest itself. Further, transparency increases with company size, board size and performance.

A comparison of executive structure and pay in the United States to that in Europe is enlightening. First and foremost, European boards consist of fourteen members on average, which is two more than the average of the United States and offers a broader representation of stakeholders. Additionally, American boards tend to have slightly more insiders, or executive directors, with an insider ratio of 0.29 compared to the average of Europe at 0.21. The Dual CEO/Chair spread is even more pronounced with the American mean of 0.79 compared to that of Europe at 0.30. Interestingly, Germany has a unique ban on insiders and duality (Muslu 2010).

A top European executive earns a meager €2.5 million compared to the €6.6 million of a top U.S. executive. Of European nations, Swiss and Italian pay the highest at €4.3 and €4.0 million, respectively. Belgian and Swedish companies pay the least at just over €1 million. Perhaps more pertinent to the topic of fair executive compensation, however, is incentive pay which measures the sensitivity of executive wealth to company performance (Pay for