Managerial Labor Market during Institutional Transition: A study of CEO compensation and voluntary turnover

• Author: Tara Shankar Shaw,Lerong He,Junxiong Fang
• Published date: 01 May 2017
• Date: 01 May 2017
• DOI: http://doi.org/10.1111/corg.12187

Managerial Labor Market during Institutional

Transition: A study of CEO compensation and

voluntary turnover

Lerong He*, Tara Shankar Shaw and Junxiong Fang

Abstract: Manuscript Type: Empirical

Research Question/Issue: This paper investigates the inf‌luence of CEOcompensation on voluntary turnoverand the moderat-

ing role of the manageriallabor market. It explores how institutional contingenciesrelated to labor market transparency,mobil-

ity, and competitiveness shape supply and demand conditions of the managerial labor market, and consequently affect the

relationship between CEO underpayment and turnover.

Research Findings/Insights: Using a sample of Chinese listed f‌irms between 2002 and 2011, we document that underpaid

CEOs are associated with a larger likelihood of voluntaryturnover in China. Importantly, wef‌ind that CEO underpayment will

increase the likelihood of voluntary turnover to a greater extent when executive compensation disclosure is mandatory, when

regional labormobility is higher,and when industry growth rate is larger. Overall, our study demonstrates that underpayment

below the market rate motivates CEOs to exit their organizations and such a reaction is more likely to materialize when man-

agerial labor market conditions are favorable enough to create a strong pull force.

Theoretical/Academic Implications: This study adopts an interdisciplinary perspectivebuilt on institutional theory, organiza-

tional psychology,and labor economics to examinethe role of the managerial labormarket during institutional transition. It in-

tegrates the social psychological explanation of turnover with the perspective of labor economics by linking both pull side and

push side drivers of organizational participation with demand and supply conditions of the managerial labor market.

Practitioner/Policy Implications: This study suggests that the design of executive compensation should consider the ongoing

labor market rate for retention and motivation reasons, especially when managerial talent is under tight supply and strong

demand.

Keywords: Corporate governance,CEO turnover,executive compensation,managerial labor market,China

INTRODUCTION

The separation of ownership and control in modern

corporations gives rise to the development of a manage-

rial labor market where business owners delegate decision-

making right to professional managers by hiring them to

administer corporations on their behalf (Fama, 1980; Fama &

Jensen, 1983). On the demand side of this market, f‌irms

compete with each other to recruit managerial talent, while

the supply side of the market contains potential candidates

seeking managerial positions (Stern & James, 2016). The

“product”transacted in this market is managerial human

capital consisting of managers’expertise, experience, knowl-

edge, reputation, skills, and may alsoinclude broadly concep-

tualized social capital embedded in managers’network

relationships(Haynes & Hillman, 2010). Mobilityof top man-

agement in the managerial labor market puts theiremployers

in a delicate position of not only losing valuable managerial

talent but also facing the risk of surrendering human assets

of these focal managers and f‌irm-specif‌ic information to their

rivals (Holcomb, Holmes, & Connelly, 2009; Mackey, Molloy,

& Morris, 2014).In response to the essential role of managerial

human capital on f‌irm success and competitive advantage,

managerial scholars have devoted considerable effort to

examine how executive compensation and other factors may

affect top management retention and voluntary turnover

(e.g., Fong, Misangyi, & Tosi, 2010; Fulmer, 2009; Shin, 2016).

The salience of managerial labor market factors in affecting

an ongoing employment relationship between managers and

their employers is shaped by the institutional environment

that market playersface (Dobbin, 2004). In developing econo-

mies undergoinginstitutional transitions, the implementation

of pro-market reforms and the increasing reliance on market

mechanisms alter the ways f‌irms and other economic actors

interact and compete, and consequently reshape their incen-

tive structures and decision-making processes (Banalieva,

Eddleston, & Zellw eger, 2015; Cuervo-Cazurra & Dau , 2009;

Peng, 2003). Such a fundamental and comprehensive change

*Address for correspondence: Lerong He, Fuzhou University, Fuzhou, China & State

Universityof New York at Brockport,Brockport, NY, USA.

E-mail:lhe@brockport.edu

© 2016 JohnWiley & Sons Ltd

doi:10.1111/corg.12187

167

Corporate Governance: An International Review, 2017, 25(3): 167–185

in the institutionalcontext raises an intriguing questionon the

role of the managerial labor market in setting executive com-

pensation and affecting executive turnover during institu-

tional transition. The answer to this question, however,

cannot be soughtfrom prior studies taking placein developed

economies where there are mature and mobile managerial la-

bor marketsas well as other market infrastructuresto facilitate

evaluation of managerial capabilities (e.g., Fee & Hadlock,

2003; Kaplan & Minton, 2012; Kaplan & Rauh, 2010; Murphy

& Zabojnik, 2004).The main objective of our study thereforeis

to explicitly examine the relationship between CEO compen-

sation and voluntary turnover and explore the role of the

managerial labor market in shaping such a relationship dur-

ing institutional transition.

Our research conte xt is China, the la rgest emerging

economy and the second largest economy in the world.

An important outcome of institutional transition in

China is the growth of labor markets for skilled labor in-

cluding management (Child & Tse, 2001; Nee, 1992). In

pre-reform China, labor mobility was under restrictive

control by the gove rnment who “not only monopolized

job provision, but also dictated all personnel transfers

across work organizations or work units”(Nee & Cao,

2004). Consequently, voluntary turnover of managers

was rather rare during this period. Limited changes in

managerial personnel were often driven by government

request rather than individual will. The strict bureaucratic

control on labor movement has been considerably loos-

ened since the economic and market reforms in the late

1990s, when the employment relationship becomes gradu-

ally def‌ined by a labor contract between employers and

employees as in western economies. As a result, manage-

rial labor mobility in China is increasingly based on the

mutual choice of potential employers and employees and

driven by the demand and supply relationship in the

managerial labor market (Peng, Sun, & Markoczy, 2015).

Such a transition in institutional context provides plentiful

variations in terms of labor market transparency, mobility,

and competitiveness, and thus offers us a natural testing

ground to explore the effect of labor market heterogeneity

on managerial compensation and turnover.

In this paper, we employ an institution-based contingency

framework to examine the role of the managerial labor mar-

ket in directly determining the benchmark level of executive

compensation, and in moderating the relationship between

executive underpayment and the likelihood of voluntary

turnover. Our study is rooted in March and Simonˈs (1958)

seminal work on organizations. In their view, employees

participation in organizations is contingent upon two major

factors: the perceived desirability of movement described as

a“push”factor, and the perceived ease of movement out of

the organization, known as the “pull”factor (Lee & Mitch-

ell, 1994). From the push side, we conf‌irm the inf‌luence of

the managerial labor market and the social comparison pro-

cess in shaping perceptions of CEOs on the fairness of their

compensation. We argue that the feeling of inequity caused

by relative underpayment compared to labor market peers

may motivate executives to voluntarily leave their f‌irms

and seek external job opportunities so as to restore equity.

From the pull side, we investigate how managerial labor

market conditions may moderate underpaid CEOs’

tendency to leave their organizations. In our view, although

CEO underpayment may trigger voluntary turnover, such a

reaction is more likely to materialize when labor market

conditions are more favorable and enticing. In this regard,

our paper supplements prior empirical studies examining

the direct relationship between executive compensation

and turnover (e.g., Fong et al., 2010; Shin, 2016; Wowak,

Hambrick, & Henderson, 2011) by explicitly investigating

institutional contingencies that affect demand and supply

conditions in the labor market.

The institution-based view of the f‌irm has attracted grow-

ing attention in corporate governance research (Judge,

Douglas, & Kutan, 2008; Wiseman, Cuevas-Rodriguez, &

Gomez-Mejia, 2012). Since the institutional environment in

which f‌irms are established and developed imprints itself

into f‌irm structures, policies, practices, and strategies, Davis

(2005) suggests that the most relevant and promising

corporate governance research should seek to understand

the institutional context in which it occurs. This is particu-

larly important for f‌irms having to comply with the con-

stantly changing institutional environment in transitional

economies (Wright, Filatotchev, Hoskisson, & Peng, 2005).

To answer this call, we investigate labor market contingen-

cies related to three institutional factors: changes of formal

compensation disclosure rules, regional heterogeneity in

labor mobility, and differences in industry growth rates. In

our view, these institutional contingencies shape supply

and demand conditions in the managerial labor market,

and consequently affect professional managers’tendency to

voluntarily leave their organizations. Such an institutional

angle thus supplements prior studies of executive turnover

to provide a more comprehensive theoretical explanation

and empirical examination of the managerial labor market

during institutional transition.

LITERATURE REVIEW AND HYPOTHESES

DEVELOPMENT

Contemporary th eoretical unders tating of the labor ma rket

is rooted in neoclassical labor market theory which views

f‌irms as price-takers (Hicks, 1932). As a result, CEO

compensation is driven by supply and demand conditions

of the managerial labor market and affected by such factors

as industry envi ronment, f‌irms’ability to pay, job require-

ments, and CEO human capital (e.g., Fulmer, 2009; Kaplan

& Rauh, 2013; Levin, 1993). A popular f‌irm-level practice

then is to benchmark CEO compensation with that of peer

f‌irms with whom the f‌irm is competing to f‌ill similar jobs

by hiring similar talent (e.g., Bizjak, Lemmon, & Naveen,

2008; Bizjak, Lemmon, & Nguyen, 2011; Faulkender &

Yang, 2010). Despite the importance of benchmarking in

executive compensation setting, executive compensation

may still deviate from the labor market rate for all sorts of

reasons. For example, Fama (1980)ˈs“ex post settling up”

argument suggests that information asymmetry between

boards and CEOs may drive CEO compensation away

from the market leve l. As a result, a given CE O may be

overpaid or underpaid relative to the ongoing labor market

rate.

168 CORPORATE GOVERNANCE: AN INTERNATIONAL REVIEW

© 2016 JohnWiley & Sons LtdVolume 25 Number 3 May 2017