Obscured transparency? Compensation benchmarking and the biasing of executive pay
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Description: See https://pubsonline.informs.org/doi/10.1287/mnsc.2018.3151 The disclosure of compensation peer groups is argued to provide shareholders with valuable information that can be used to scrutinize CEO compensation. However, research suggests that there are substantial incentives for executives and directors to bias the compensation peer group upward such that the CEO can extract additional rent. We leverage the idea that reciprocated peer nominations are unlikely to be biased in order to construct counterfactual peer groups that allow us to measure the bias of disclosed peer groups. Analyses of eleven years of comprehensive data on compensation peer groups demonstrate that the average ﬁrm uses an upwardly biased peer group. The size of the bias increases when incentives and opportunities to do so are more pronounced. Speciﬁcally, results show that bias is larger when ﬁnancial targets are not met and when exercising discretion in the selection of peer ﬁrms is justiﬁable. More importantly, upward bias in compensation peer groups is highly predictive of an increase in CEO compensation – suggesting that there is a strong incentive for CEOs to strategically select peers. Finally, while average peer group bias has gone down in recent years, the predictive eﬀect of bias on pay has gone up. These ﬁndings call into question the practical impact of recent eﬀorts to introduce greater transparency into the process for determining executive compensation.