Corporate Governance

Excessive Executive Pay Makes Headlines, But So What?

A study shows that media clamor over high executive compensation makes virtually no difference in company behavior.

April 01, 2008

| by Alice LaPlante

Major accounting fraud aside, there are few business activities the news media seem to delight in exposing as much as excessive executive compensation. But recent research shows that these types of headlines might not make all that much difference in how corporations actually behave.

“Say the press does hammer away on some company. The question then becomes,’So what?’” said David Larcker, professor of accounting at Stanford GSB. “Most companies don’t seem to care enough to substantially change their pay practices.” They might shift the mix of compensation a bit — from cash payments to stock options, for example — but in terms of the total compensation, press exposure doesn’t really seem to matter.

Obviously, there are some executives who create a lot of value and you want to pay them a lot,” said Larcker. “But there are other instances when you say, ‘Wow, how did this guy get paid this much money?’”

The impetus for the research came when Larcker and his colleagues were trying to understand what might help put constraints on excessive executive pay. One of the things that earlier research has highlighted is the potential role of the press as a watchdog for catching particularly egregious levels of compensation. “Two issues emerged,” said Larcker. “First, is the press picking the right executives to pillory; and second, does it make a difference?”

The answer to the first question is perhaps. The answer to the second is a resounding no.

Part of the reason that publication of negative articles about executive pay appears to have little effect may be that it actually satisfies two very different kinds of public demands. On the one hand, excessive compensation is known to be a sign of poor governance — clearly an important issue for shareholders, employees, suppliers, and society at large. At the same time, multimillion-dollar pay packages and the potential scandals surrounding the wealthy individuals who receive this kind of pay can be very entertaining. For example, there were repeated references in the press coverage of Tyco International CEO Dennis Kozlowski’s excessive pay to the $6,000 shower curtain he had purchased for his corporate apartment.

“You would think that if you had a scathing review by the New York Times, the Wall Street Journal, or the Washington Post that you would have to deal with it in some way — at the very least through a public relations effort,” said Larcker. “And you’d expect that if people are reading the stories, there would be a groundswell of opposition among shareholders. But it seems as though it is largely ‘fun’ reading with no impact.”

Using more than 15,000 press articles about CEO compensation from 1994 to 2002, the study found some evidence that the press “gets it” and actually reports on executive compensation with some degree of sophistication, said Larcker. For example, the press seems to make adjustments for standard economic determinants of compensation such as industry and size of company before producing a negative article. However, consistent with charges of sensationalism, the researchers also found evidence that the press focused chiefly on large payouts, even when the pay was from multi-year compensation programs. In addition, there was little evidence that companies changed their compensation practices in response to harsh criticism by the press.

“This is a just a first pass at a set of research that we are going to pursue as a group here in the accounting department, trying to understand the issues surrounding media and governance,” said Larcker. “For example, we are also analyzing interviews and other communication in an effort to detect lying by corporate officers. Such research promises to provide new insights in predicting accounting restatements, fraud, and stock price performance.”

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