CEO Pay from a Social Norm Perspective: The Infringement and Reestablishment of Fairness Norms

• Author: Katja Rost,Antoinette Weibel
• Date: 01 July 2013
• DOI: http://doi.org/10.1111/corg.12018
• Published date: 01 July 2013

CEO Pay from a Social Norm Perspective:

The Infringement and Reestablishment of

Fairness Norms

Katja Rost and Antoinette Weibel

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Social norm theory goes beyond economic eff‌iciency arguments and provides a framework that

allows for the subjective, judgmental, and sociallyinteractive processes involved in the determination of CEO remuneration.

Building on this theory,we argue that current CEO pay practices infringe a social norm. This norm states that a f‌irm’s wages

ought to be fair. Thus, accordingto the social norm theory view, large inequalities between CEO pay and low-level incomes,

as well as inequity concerns of CEO pay decoupled from performance, become a matter of public distress. If such publicly

shared fairness norms become infringed, some amount of norm enforcement becomes likely, particularly when the pun-

ishment is of low cost. Norm enforcement also becomes likely if selective incentives and/or intrinsic norm enforcement are

present to support punishing actions.

Research Findings/Insights: We test our model using a vignette-survey study and a representative sample of 800 Swiss

citizens. We are able to show that individual differences – more precisely status attributes and moral development – drive

perceptions of norm infringement. We demonstrate that the willingness to punish f‌irms with norm-infringing CEO pay is

high if low-cost punishment opportunities are provided, such as public votes on CEO pay regulation. In addition, the

willingness to punish is also driven by feelings of deprivation which fuel intrinsic interest to punish norm infringers even

at high individual costs.

Theoretical/Academic Implications: We adapt and contextualize social norm theory for the CEO pay debate. A model that

explains how individual differences drive norm infringement perceptions, and how these differences lead to behavioral

punishment intentions, is developed and tested empirically.

Practitioner/Policy Implications: The war for talent and the urge to offer incentives to CEOs impose costs on society, and

f‌irms are confronted with those costs. As a consequence, more and more people demand CEO pay regulation, which

narrows f‌irms’ latitude. For f‌irms, the evidence implies that they would be well advised to consider the climate of public

opinion when determining executive pay. They may either reduce CEO pay or should communicate to the public why

certain compensation designs may be favorable and in the interests of the enterprise and stakeholders. For politicians, the

f‌indings of our study show that there is a demand for CEO pay regulations and that this demand has to be acknowledged

in some way in policy-making.

Keywords: Corporate Governance, CEO Pay, Social Norms, Norm Infringement, Fairness

INTRODUCTION

In the last ten years, CEO pay has been discussed exten-

sively in the press. Underlying this attention is the

worldwide increase of CEO pay (for an overview, see

Kaplan, 2008; Walsh, 2008). From 1970 to 2008, the average

CEO pay in US S&P 500 f‌irms rose by a factor of 12.5

(Faulkender, Kadyrzhanova, Prabhala, & Senbet, 2010).

In Europe, numbers are comparable (Rost & Osterloh,

2009; Schwalbach, 2008). As a consequence, some CEOs of

large public companies today earn 500 times more than

the lowest-paid worker in their companies (Anderson,

Cavanagh, Collins, Pizzigati& Lapham, 2008). These discus-

sions in the public arena have been primarily focused on the

lack of fairness in the rising income gap between CEO and

non-managerial employees, as well as on moral issues per-

*Address for correspondence: Katja Rost,Institute of Sociology, University of Zurich,

Andreasstr. 15, 8050 Zurich, Switzerland. Tel: 044 635 23 10; Fax: 41 44 635 23 99;

E-mail: katja.rost@uzh.ch

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Corporate Governance: An International Review, 2013, 21(4): 351–372

© 2013 John Wiley & Sons Ltd

doi:10.1111/corg.12018

taining to CEO pay, particularly whether CEO pay is still

justif‌ied by top management performance.

The majority of research on CEO pay, particularly in

f‌inance and strategy, has analyzed CEO pay practices – both

the size of CEO pay as well as its composition, which has

moved from more f‌ixed-pay to more f‌lexible, contingent pay

elements – from a narrower and more descriptive perspec-

tive. By drawing on economic eff‌iciency arguments, CEO

wages have been explained by their relationship to company

performance (Hall & Liebman, 1998; Jensen & Murphy, 1990;

Murphy, 1999; Nyberg, Fulmer, Gerhart, & Carpenter, 2010;

Tosi, Werner, Katz, & Gomez-Mejia, 2000) or by their depen-

dency on labor markets (Bebchuk & Fried, 2004; Gabaix &

Landier, 2008; Kaplan & Rauh, 2010; Murphy & Zábojník,

2007; Rajgopal, Shevlin, & Zamora, 2006).A societal perspec-

tive that embraces the “subjective, judgmental and socially

interactive processes also involved in determining CEO

remuneration” (O’Neill, 2007:699) has, however, been rela-

tively rare. Some authorshave argued on a purely theoretical

basis in order to include normative discussions in CEO pay

research (e.g., Walsh, 2008), while others have studied norm-

based aspects of CEO pay empirically, but without an

explicit norm-based analysis(Kuhnen & Niessen, 2012; Zajac

& Westphal, 1995). Hence, the call of scholars such as Simon

(1957), Zajac and Westphal (1995) and, most recently, Walsh

(2008), to broaden research on CEO pay and to include a

norm-based perspective on what constitutes a justif‌iable

compensation for CEOs in the eyes of stakeholders at large,

is still largely unanswered.

The necessity to study CEO pay from a broader societal

view is also growing in practical relevance (Lamin & Zaheer,

2012). For example, in 2002, the UK government introduced

a “say on pay” initiative against a background of public

outrage about the rising level of CEO compensation

(Conyon & Sadler, 2010). In the United States, the Dodd-

Frank f‌inancial reform legislation (passed in July 2010)

allows shareholders a nonbinding vote on executive com-

pensation. In Germany, a new law concerning the adequacy

of executive remuneration (VorstAG) came into force in

2009; listed stock companies must implement a compensa-

tion structure that promotes a long-term and sustainable

perspective (Bundesrat, 2009). Similarly, in Switzerland, two

political initiatives against high executive pay will be put to

a public vote: one seeks to institutionalize shareholder

voting on CEO pay, and the other initiative aims at limiting

the CEO–worker pay gap (NZZ, 2012).

The aim of this paper is to analyze public reactions to

current CEO pay by drawing on a social norm perspective.

Building on social norm theory (Coleman, 1990; Elster, 1989;

Fehr & Fischbacher, 2004; Metze, Mühler, & Opp, 2000;

Olson, 1965; Opp, 1979; Posner & Rasmussen, 1999), we

analyze whether a broad consensus exists that current CEO

pay practices lack normative legitimacy, i.e., such practices

are not considered to be right and just from a general public

point of view. We propose that CEO pay practices, which

infringe the social norms of “ought to be fair and morally

acceptable,” impose costs on society, such as social depriva-

tion and moral concerns. According to social norm theory,

those who cause negative externalities, that is, f‌irms that pay

extraordinarily high CEO pay in relation to “average Joe”

wages and/or CEO pay decoupled from performance, are

confronted not only with polite requests, but also with pun-

ishments and normative demands, to obey norms (Opp,

2002). We analyze under what conditions such punishments

are likely to take place and whether in the current situation,

f‌irms are likely to face new and strong demands from the

general public to re-establish the legitimacy of their CEO pay

practices.

Our empirical context is Switzerland. The result of a

vignette study relying on a representative sample of 800

citizens demonstrates that current CEO pay practices breach

widely shared norms of fairness and moral behavior. Fur-

thermore, respondents indicate that they are willing to sanc-

tion the infringement of these norms. In particular, those

respondents who experience the highest negative externali-

ties and who are emotionally concerned about CEO pay

practices are willing to enforce norms of fairness and of

moral behavior by supporting political initiatives and pun-

ishing norm infringers.

CEO PAY FROM A SOCIAL NORM

PERSPECTIVE

Social Norms

Social norms, their function, emergence, and maintenance,

have been atthe heart of most social sciences. Rational choice

theory, in particular, has focused on how social norms

evolve, shape individual behavior and are sustained. “A

norm is understood as a statement that something ought or

ought not to be the case” (Opp, 2002:132). Norms that are

characterized as social “must be shared by other people and

partly sustained by their approval and disapproval” (Elster,

1989:99 f.). Social norms are often created intentionally

because they promote the provision of a (f‌irst-order) public

good, for example, less pollution in a neighborhood because

of burning leaves (Diekmann & Preisendörfer, 1992), less

harm to health through smoking (Opp, 2002), or less unfair-

ness due to high income differentials (Fehr & Schmidt, 1999).

In addition, new empirical research in behavioraleconomics

demonstrates that some social norms seem to be “hard-

wired” to human behavior. For instance, a sizeable number

of experiments have found a strong disapproval of inequal-

ity (Guth & Napel, 2006), particularly strongly felt by those

who are embedded in a social context with relatively high

norms of equality (Elster, 1989).

It has been shown that people accept social norms if the

environment signals that norms count (Keizer, Lindenberg,

& Steg, 2008), if the costs for norm-conforming behavior are

low (Diekmann & Preisendörfer, 1992; Rauhut & Krumpal,

2008), and if the amount of deviant behavior is unknown

(Diekmann, Przepiorka, & Rauhut, 2011). To be sustainable,

however, social norms need to be enforced, as otherwise

Olson’s (1965) zero contribution holds: “if all rational and

self-interested individuals in a large group would gain as a

group if they acted to achieve their common interest or

objective, they will still not voluntarily act to achieve that

common or group interest” (Olson, 1965:2).

Social norms thus are effective because they are enforced

by simple sanctions, such as guilt and shame, as well as

by bilateral and multilateral costly sanctions (Posner &

Rasmussen, 1999). Those who cause externalities are not just

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