The impact of public scrutiny on executive compensation

Author:Andrew Glen Carrothers
Position:University of Prince Edward Island, Charlottetown, PE, Canada

Purpose This paper aims to examine the impact of public scrutiny on chief executive officer (CEO) compensation at Standard & Poor’s (S&P) 500 firms. Design/methodology/approach This paper uses the unique opportunity provided by the 2008 financial crisis and, in particular, government support and legislated compensation restrictions in the US Department of the Treasury’s... (see full summary)

The impact of public scrutiny
on executive compensation
Andrew Glen Carrothers
University of Prince Edward Island, Charlottetown, PE, Canada
Purpose This paper aims to examine the impact of public scrutiny on chief executive ofcer (CEO)
compensationat Standard & Poors (S&P) 500 rms.
Design/methodology/approach This paper uses the unique opportunity provided by the 2008
nancial crisis and, in particular, government support and legislated compensation restrictions in the US
Department of the Treasurys Troubled Asset Relief Program (TARP). It aggregates monetary and non-
monetary executive compensation information from 2006 to 2012, with rm- and manager-level data. It
presents univariate summary compensation results and uses multivariate regression analysis to isolate the
impact of publicscrutiny and legislated compensation restrictionson executive pay.
Findings Overall, the results are consistent, with increasedpublic scrutiny having a lasting impact on
perks and temporaryimpact on wage and legislated compensation restrictions having a temporaryimpact on
wage. Changes in specic perkitems provide evidence on which perks rms perceive as excessive and which
provide commonvalue.
Originality/value The paper contributesto the discussion of perks as excess by introducing a novel data
set of perk compensation at S&P500rms and by studying how rms choose to alter levels of specicperk
items in responseto increased public scrutiny and legislated compensation restrictions.The paper contributes
to the literature on executive pay as there has been little inquiry into the impact of public scrutiny on
compensation. Publicscrutiny could be an important source of external governance if rms change behavior
in responseto explicitand implicit scrutiny costs.
Keywords Financial crisis, Private benets, Executive compensation, Perks, Public scrutiny
Paper type Research paper
The nancial crisis of 2008 is arguably the largest global macroeconomic shock since
the Great Depression. There is widespread blame for the crisis on excessive risk-taking
by executives at nancial institutions, with accusations that the structure of
compensation plans incented these executives to embrace risks (Haan and Vlahu, 2016
and DellAtti et al., 2013). Over the past decades, compensation committees of company
boards of directors adjusted the structure of pay packages with the express purpose of
minimizing agency conict by aligning interests of top executives and shareholders
(Faulkender and Yang, 2010). Yet, it is these very compensation plans that became the
subject of heated criticism. Calls for reform of executive compensation are widespread
in academic, political and public circles and are coincident with a dramatic increase in
executive compensation since the 1980s (Hall and Murphy, 2003). Compensation
reformists became increasingly vocal as scrutiny of executive pay intensied in the
wake of the nancial crisis (Bebchuk et al., 2010). Effective October 3, 2008,
the Emergency Economic Stabilization Act (EESA) established TARP in response to
the deterioration of the US stock market. TARP is an umbrella program, with initiatives
that fall into six different categories. Under the Executive Compensation Program,
TARP recipients became subject to executive compensation restrictions while they had
Received22 July 2017
Revised5 November 2017
12February 2018
Accepted3 August 2018
Journalof Financial Regulation
Vol.27 No. 3, 2019
pp. 303-323
© Emerald Publishing Limited
DOI 10.1108/JFRC-07-2017-0060
The current issue and full text archive of this journal is available on Emerald Insight at:
outstanding TARP obligations. The TARP legislation included compensation
restrictions because of political and public concerns about using taxpayer money to bail
out rms that had excessive compensation schemes. Government support acted as a
trigger to expand the debate on CEO pay because the legislation made support
contingent on compensation restrictions.
Three primary arguments for the levels and increases in CEO pay are managerial rent
extraction (Bebchuk and Fried, 2004), optimal contracting in competitive labor markets
(Edmans and Gabaix, 2009) and reward for accepting compensation contracts with
proportionately higher levels of at-risk incentive pay (Murphy, 2002).Thereisextensive
literature examining the impact of rm size (Gabaix and Landier, 2008), rm performance
(Jensen and Murphy, 1990) and human capital (Murphy and Zabojnik, 2004)onCEO
compensation. Regardless of the reason for high pay packages, executive compensation
became an increasingly important corporate-governance issue as public scrutiny
intensied in step with reformist rhetoric. From a governance perspective, public
scrutiny is the examination and monitoring of rms by broad segments of the population,
with the aim of improving rm performance. The denition is encompassing and would
include, for example, critical observation by government entities, politicians, media,
shareholders and voters. Wiersema and Zhang (2013) nd that scrutiny by media and
government of stock option backdating, rather than the backdating itself, causes rms to
take corrective action to demonstrate to stakeholders a commitment to resolving
problems. Lokanan (2017) cites scrutiny by regulators and investor advocates as a factor
in efforts to improve self-regulatory enforcement in the securities industry. Dyck and
Zingales (2002) show that public scrutiny, specically media attention, inuences
corporate governance to affect shareholder value and corporate social responsibility. Jia
et al. (2016) examine the impact of negative media coverage on rms. Gan (2006) nds
that public scrutiny can impact rms through legal or economic costs of dealing with
special interest groups, compliance costs of government regulations and implicit costs of
negative media coverage of rm misbehavior. However, little is known about the
inuence of public scrutiny on executive pay. In one of the few related studies, Core et al.
(2008) nd a strong relationship between negative media coverage and both excess CEO
pay and high levels of exercised options but nd little evidence that the negative media
coverage (i.e. heightened scrutiny) leads to decreased compensation. Setting executive
pay is the prerogative of rmsboards of directors acting as principals on behalf of the
shareholders. Increasing explicit and implicit scrutiny costs may inuence the boards
decisions about compensation structures and levels.
The nancial crisis and TARP legislation provide an interesting opportunity to re-
examine whether the costs of publicscrutiny are high enough to cause changes in executive-
compensation practices. First,I use the years surrounding the crisis to examine time trends
in compensation in responseto changing levels of public scrutiny.The nancial crisis likely
increased public scrutiny at all S&P500 rms. For example, the crisis caused widespread,
large declines in equity values, unfavorably impacting investments and savings of broad
cross sections of the population. In addition, liquidity evaporated during the crisis and
actions by rms to preserve cash affected job security and wages. As the impact of crisis
had tangible effect on individuals, the media and the public at large subjected rms to
increased scrutiny. In particular, perceived excess in compensation practices at recipients of
government bailout funds acted as a lightningrod for scrutiny as the media, politicians and
public demanded accountability to ensure protection of taxpayer resources. For example,
Andrews and Bajaj (2009) quotePresident Obama:

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