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Factors That Impact the CEO’s Salary, Research Paper Example

Pages: 5

Words: 1381

Research Paper

Introduction

In the modern economic setting, it is apparent that CEOs make a large sum of money compared to their employees. In fact, the United States has the highest CEO salary to worker salary ratio in the world. Many business professionals have reported that CEOs make only 20% of their funds as a base salary. Additional incentives are typically provided to the individual to establish business agreements, which is problematic for economists that wish to gain a more reflective understanding of the wages of CEOs. Because these salaries are earned as a combination of base pay and incentives, there are a variety of factors that impact the CEO’s salary.

The success of the organization is directly related to the ability of the CEO to make more money. Such raises are more permissible when the company is successful and there is a large amount of funds that are available. Additionally, this decision seems to be more favorable when executives have had positive relationships with the board. It would therefore be valuable to further explore the concept of the relationship of the CEO and the board in terms of trends in the salaries of CEOs. It is beneficial to generate this understanding because business professionals will have a better understanding of how a combination of economic conditions of the company and relationships between executive employees will contribute to the development of enhanced CEO salary.

Literature Review

To determine the relationship between board control and CEO salary, Brian K. Boyd initiated the “Board Control and CEO Compensation” study (Boyd 335). The author proposed that increase board control would contribute to the likelihood that the salary would increase, while a lessened degree on board control would correlate with a lower salary. These results could reasonably be used to understand how CEOs could operationalize board control, therefore allowing themselves to gain access to a higher salary. A conceptual model was therefore developed to measure board control and to determine the relationship of this variable with CEO compensation. To conduct this study, data on board composition and CEO compensation was collected from a total of 193 firms specializing in a variety of industries. Hypothesis testing was also provided to determine relevant implications for studies in the future.

The literature indicated that firm performance is classically thought to have been one of the primary reasons for CEO salary increase, but studies of this nature have failed, which has created a need for scientists to determine other variables that may serve as factors in this relationship. However, there is some indication that profitability and sales growth, in particular, are related to this trend in growth. Studies of compensation and stock returns have determined that there is no relationship between these two variables, while other individuals believe that there is a positive correlation. Ultimately, it is challenging to utilize these types of datasets because the variance seen among these data sets is relatively high. An important way of resolving this dilemma is by ensuring that random selection is being used and that these individuals selected are reflective of the general population.

It is also important to consider that employee compensation practices may vary across firms. Therefore, it is individual organizational practices that would contribute to the ability of the CEO to experience an increase in salary. The board under agency theory supports this concept because agency risks are reduced due to the strengthened relationship between the executive and the agency. On occasion, the executives on the board and the CEO don’t tend to see eye to eye. When this occurs, the organization will develop tension, which will create relevant social strain between these parties. However, when it could be avoided, both the organization and the CEO will benefit. It therefore seems apparent that stronger boards contribute to greater profitability. Because these two factors are related, it seems that both or either of these factors could contribute to an increase in executive salary. Therefore, it is important to conduct analyses of this kind in order to determine the presence of confounding variables that may be present in the data.

In this study, the data was collected from 193 firms in 12 different industries. All data was taken during the year 1980. It is important to consider that even though this was done two and a half decades ago, the relationship between board cooperation and CEO salary should be reflective of the relationship present in the current economic setting. The United States has become involved in different conflicts and trade deals since this time period, but the economy of the nation is in roughly the same state. Furthermore, these differences were accounted for in the initial analysis, which indicates that industry groups were selected to represent a broad range of market conditions.

In the study, CEO compensation was considered to represent a combination of traits, including, base salary, bonus, and long-term or deferred income. This definition was selected because it is the one used in most assessments of CEO compensation in the academic setting. Board control requires that these individuals have sufficient incentive and are free from collusion or domination by the CEO. Since this concept describes a more positive relationship between the executives, board control is not taken by force. A structural model that incorporates multiple measured of board control were used in this analysis because it would allow for the completion of a more powerful examination of the control-compensation model, posed here. One of these factors includes the concept of CEO duality status, which occurs when a CEO also serves as the chairmen of the board of directors. The ratio of insiders on the board must also be considered for this purpose. An additional factor is board stock ownership because it allows control responsibilities to be fulfilled more readily. The final factor is the concept of level of director compensation, because it is expected that CEOs will have higher salaries when their directors are provided with a salary increase as well. Firm size and profitability were also considered.

The relationship between these variables were tested using LISREL VII to gain a better understanding of variables that imperfectly represent latent constructs. The significance of the chi-square data was examined in addition to a variant of this test to adjust for the degrees of freedom looked at thin this study. The goodness of fit was also used to determine fit independent of the sample size. The root mean square residual was then assessed to determine the magnitude of the relationship. Last, the magnitude of the coefficient of determination for compensation was determined.

It was determined that the average amount of earning by the CEOs in the study was $215,914, with figures ranging from $56,050 and $654,253 at either end of the relationship. It was also found that CEO duality and director compensation loaded negatively on board control. Furthermore, “board stock ownership and board representation by ownership groups loaded positively on board control. Last, the insider ratio loaded positively on the board control dimension” (Boyd 340). It was found that CEO salaries are higher in organizations with lesser levels of board control, while CEO compensation was not related to the size of their firm or their profitability.

Conclusion

In conclusion, board control is related to CEO salary; as board control weakens, CEO salary tends to increase. Furthermore, factors related to the size of the firm or the firm’s profitability does not impact CEO compensation. Thus, firms can use their understanding of this relationship in order to implement CEO and board relationships that are in the best interest of the company. In some instances, it might be financially troubling to increase the salary of the CEO due to the funds present at the organization. However, in some cases, it may be reasonable to increase the salary of the CEO as an incentive to allow them to continue their excellent performance. It would be valuable to determine additional factors that examine the relationship between CEO salary and board relationship in the future. It is possible that the relationship between CEO salary and performance may be blinded by the fact that it is salary that influences performance instead of vice versa. However, it is important for organizations to continue taking the actions that they think to be necessary to ensure that their organization remains successful.

Works Cited

Boyd, B.K. Board Control and CEO Compensation. Strategic Management Journal 15(1994):   335-344.

http://www.researchgate.net/profile/Brian_Boyd2/publication/229664643_Board_control_and_ceo_compensation/links/540d04730cf2df04e7547715.pdf

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