Do Compensation Consultants Drive Up CEO Pay? Evidence from UK Public Firms
| Published date | 01 January 2019 |
| Author | Lars Helge Hass,Martin J. Conyon,Graham V. Sadler,Simon I. Peck,Zhifang Zhang |
| Date | 01 January 2019 |
| DOI | http://doi.org/10.1111/1467-8551.12307 |
British Journal of Management, Vol. 30, 10–29 (2019)
DOI: 10.1111/1467-8551.12307
Do Compensation Consultants Drive Up
CEO Pay? Evidence from UK Public Firms
Martin J. Conyon, Lars Helge Hass,1Simon I. Peck,2Graham V. Sadler3
and Zhifang Zhang 4
Bentley University, Massachusetts, MA 02452, USA and The Wharton School, University of Pennsylvania,
Philadelphia, PA 19104, USA, 1Lancaster UniversityManagement School, Lancaster University, Lancaster
LA1 4YX, UK, 2WeatherheadSchool of Management, Case Western Reserve University, 10900 Euclid Avenue,
Cleveland, Oh 44106–7235, USA, 3Coventry University, Priory Street, Coventry CV1 5FB, UK, and 4Essex
Business School, University of Essex, Colchester CO4 3SQ, UK
Corresponding author email: z.zhang@essex.ac.uk
Do compensation consultants drive up CEO pay for the benefit of managers, or do they
design pay packages to benefit firm owners? Using a large sample of UK firms from
the FTSE All-Share Index over the 2003–2011 period, we show a positive correlation
between the presence of compensation consultants and CEO pay. Importantly, isolat-
ing this eect is somewhat dependent on the endogenous selection of consultants and the
statistical modelling strategy deployed. Wefind evidence that compensation consultants
improve CEO compensation design when their expertise is of greater importance (e.g.
during the post-financial crisis period, or for firms that have particularly weak compen-
sation policies). In addition, our findings show that compensation consultants increase
CEO pay–performance sensitivity. The balance of evidence supports optimal contracting
theory more than managerial power theory, but the authors caution the limits to this veri-
fication. We arecareful to note that the more compelling evidence for the positive eect of
pay consultants on CEOs is based on advanced methods (such as propensityscore match-
ing and dierence-in-dierences), and that more standard approaches (such as OLS and
fixed eects) are unlikelyto reveal the same level of causality of consultants on CEO pay.
Introduction
This paper investigates the relations among com-
pensation consultants, CEO pay and managerial
incentives. Specifically, we address whether the
presence of consultants tends to raise CEO pay
and/or change the structure of incentive-based pay.
The central issue is whether pay consultants im-
pede or improve compensation arrangements in
the boardroom. Our paper augments the litera-
The authors would like to thank Marc Goergen (the edi-
tor), the anonymous referees,Bianca Beyer, WenjiaoCao,
Zhangfan Cao, Daniel Ferreira,Kevin Jackson, Facundo
Mercado, Beatriz Garcia Osma, William Rees, Yanlei
Zhang, and participants at the XII International Ac-
counting Symposium for helpful comments.
ture on compensation consultants and CEO com-
pensation (Armstrong, Ittner and Larcker, 2012;
Conyon, Peck and Sadler, 2009; Murphy and
Sandino, 2010).
Studying compensation consultants is impor-
tant because their role in setting CEO pay is
controversial (Waxman, 2007). Managerial power
theorists argue that compensation consultants
are captured by powerful CEOs, leading to
non-optimal and excessive executive compensa-
tion arrangements (Bebchuk and Fried, 2006;
Waxman, 2007). In consequence, executive pay
arrangements favour CEOs at the expense of
owners and society. Agency theorists, in contrast,
argue that pay consultants use their expertise to
align the interests of owners and managers and
help alleviate moral hazard risks arising from the
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Do Compensation Consultants Drive Up CEO Pay? 11
separation of ownership and control. In this
view, CEO pay arrangements are largely optimal,
and are set against inevitable contracting costs
(Conyon, Peck and Sadler, 2009; Murphy and
Sandino, 2010). There is thus a tension between
these two theories, in principle, which can be
addressed empirically. Disentangling these two
claims is fraught with diculty, not least because
the firm’s selection of consultants is endogenous
and/or prone to other statistical biases arising
from omitted variable bias. This paper aims to
address these issues.
Our paper makes the following contributions
to the literature on pay and governance. First, we
contribute to the extant compensation consultant
literature by showing that the ability to establish a
correlation between CEO pay and pay consultants
is highly sensitive to the type of econometric
method used. Specifically, the long panel of data
on UK publicly traded firms enablesus to test both
the cross-sectional and time series relationships
between CEO compensation and compensation
consultants. Prior research has focused largely
only on the cross-sectional variation in the pay
and compensation consultant relationship. Our
cross-sectional OLS results show that the presence
of consultants is positively associated with both
level of compensation and percentageof incentive-
based pay, consistent with prior literature (e.g.
Conyon, Peck and Sadler, 2009; Voulgaris,
Stathopoulos and Walker, 2010). However, by ex-
ploiting the time series nature of the data, we show
that these findings do not adequately control for
firm-specific heterogeneity in corporate culture,
managerial quality or the endogenous selection
of consultants. When we control for these factors,
the eect of consultants on CEO pay is much
less clear-cut. To elaborate, we find that the eect
of pay consultants on the level of CEO pay and
the structure of CEO incentives disappears after
controlling for firm- and CEO-level fixed eects.
Second, given that the presence of compen-
sation consultants is endogenous, we do not
consider findings from the OLS/FE models suf-
ficiently convincing as a way to isolate the causal
eect of consultants on CEO pay. We therefore
use more compelling econometric methodologies,
including propensity score matching, to identify
optimally similar consultant and non-consultant
firms and isolate the average treatment eect
of the compensation consultants on CEO pay
(Angrist and Pischke, 2009; Rosenbaum and
Rubin, 1983). Moreover, we follow this up using a
dierence-in-dierences (DiD) estimator using the
2008 financial crisis as an exogenous shock to ob-
serve CEO pay adjustments. While the economic
magnitude of the consultant eect decreases, we
document a positive link between the presence of
compensation consultants and CEO pay, using the
propensity score matching method. We also find
that the presence of compensation consultants
increases CEO pay in the post-2008 financial
crisis period. The impact is driven mainly by an
increased proportion of equity-based pay. This
suggests that compensation consultants helped
firms rearrange their executive compensation
packages to gain back the public’sconfidence after
the financial crisis.
Third, we investigatethe contexts in which com-
pensation consultant advice matters. Wealso show
that compensation consultants aect the level of
CEO pay and the structure of incentiveswhen their
expertise is more likely to be important. Specifi-
cally, we find that the eect of compensation con-
sultants on CEO pay is driven by their impact on
firms with observable ex ante weak compensation
policies.This is consistent with the expectation that
shareholders face greater moral hazard risks in
firms with weak compensation policies, and that
these firms are more likely to rely on and benefit
from consultants’ advice.
Fourth, weadd to prior findings in the literature
by showing thatt hereis a positive relation between
consultants and CEO pay–performance sensitivity
(PPS), indicating that the CEO pay is more linked
to performance (both stock returns and return on
assets (ROA)) in firms that retain compensation
consultants.
Finally,we conduct a battery of additional anal-
ysis to investigate the eects of compensationcon-
sultants’ quality on CEO pay, the determinants
of changes in compensation consultants, the ef-
fect of internal adviser and compensation commit-
tee characteristics on CEO pay, as well as the ef-
fects of consultants on CEO pay in firms across
dierent regulatory regimes. Our evidence adds
to the wider corporate governance literature, with
a special focus on executive compensation (e.g.
Skovoroda and Bruce, 2017; Stathopoulos and
Voulgaris, 2016).
The remainder of the paper is organized as
follows. The next section reviews the relevant
literature and develops our main hypotheses.
The third section describes the sample selection,
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