Testing the Participation Constraint in the Executive Labour Market
| DOI | http://doi.org/10.1111/sjpe.12102 |
| Author | Brian G. M. Main,Ian Gregory‐Smith |
| Published date | 01 September 2016 |
| Date | 01 September 2016 |
TESTING THE PARTICIPATION
CONSTRAINT IN THE EXECUTIVE
LABOUR MARKET
Ian Gregory-Smith* and Brian G. M. Main**
ABSTRACT
This paper tests the participation constraint by examining the workings of the
executive labour market in a panel of UK listed companies over a period of
14 years. Directors are found to move jobs regularly –both within companies
and between companies. Consistent with agency theory, directors who are under-
paid relative to their comparable peers are particularly likely to leave for higher
paying jobs in other companies. Those who move between companies secure more
favourable terms than those who move within their firm –even when the move
does not involve promotion, calling into question the managerial power perspec-
tive of this area of employment.
II
NTRODUCTION
With its high level of transparency and the relative ease with which payment
can be gauged against company productivity measures, the topic of executive
pay offers attractive opportunities to test rival theories of pay determination
(Perkins and White, 2011). Early work focused on the Chief Executive Officer
(CEO) (Roberts, 1956; Lewellen, 1968; Cosh, 1975), but as data availability
improved and with the realization that the entire team of executive directors
was being remunerated in much the same way as the CEO, it became more
usual to speak in terms of executive pay (Bender and Moir, 2006; BIS, 2011).
As will be discussed below, the incentive aspect of these arrangements, the
pay-performance-relationship, has come to dominate policy discussions:
Ridiculous levels of remuneration are going unchallenged as the
norm, when there is no clear evidence of a correlation with per-
formance. Vince Cable to ABI 2011
But, the mantra of labour economists (Ehrenberg, 1990) is that remunera-
tion packages must be designed to ‘attract, motivate and retain’. One implica-
tion being that if the labour market is competitive then agents are able to
move to better rewarded positions should the current job not turn out as
*University of Sheffield
**University of Edinburgh Business School
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12102, Vol. 63, No. 4, September 2016
©2015 Scottish Economic Society.
399
expected. In the field of executive pay, this view is pervasive and finds its way
into governance codes (Combined Code, 2003 2009) and institutional guideli-
nes (ABI, 2006). But there is an opposing view which portrays executive pay as
being essentially the result of the opportunistic exploitation of managerial
power (Bebchuk and Fried, 2004). Here, remuneration is seen as being deter-
mined predominantly within an administrative framework, and one that is sub-
ject to manipulation by the key players. In this view, the managerial labour
market is but a rhetorical device which comes in handy when pay awards need
to be justified at the Annual General Meeting (AGM) or in reports to sharehold-
ers (Wade et al., 1997). Discussion in the trade and popular press leans towards
the latter portrayal of the situation. Notwithstanding some 20 years of almost
continuous corporate governance reform (Cadbury, 1992; Greenbury, 1995;
Hampel, 1998; DTI, 2002; Higgs, 2003; Combined Code, 2009), there is a deep
scepticism as to the existence of a functioning competitive executive labour mar-
ket. This paper offers an empirical assessment of a key aspect of the market-
based perspective of executive pay, namely the participation constraint.
In the United Kingdom, the Directors’ Remuneration Report Regulations
(DTI, 2002) oblige the remuneration committee to produce an annual report
on directors’ remuneration and to defend this report at the company’s AGM,
where it is subject to a shareholder vote.
1
Although the Directors’ Remunera-
tion Report covers both executive and non-executive directors, most attention
focuses on executive directors. Henceforth, we will talk in terms of ‘executives’
meaning executive directors. When members of remuneration committees are
questioned as to their decisions regarding pay awards, they invariably revert
to discussion of the executive labour market (Perkins and Hendry, 2005; Lin-
coln et al., 2006; Main et al., 2008). At best, what is offered is anecdotal in
nature. Quantitative research in the area (Gregg et al., 1993; Conyon, 1998;
Conyon and Murphy, 2000; Fattorusso et al., 2007; Girma et al., 2007; Con-
yon and Sadler, 2010) has tended to focus on the design of executive remuner-
ation and its incentive properties (the ‘motivate’ component). But a
substantial part of the remuneration committee’s work focuses on the level or
‘quantum’ of pay. There are only a limited number of papers that deal
directly with the participation constraint or the ‘attract and retain’ properties
of executive pay, notably Gabarro (2012), Murphy and Zabojnik (2007), Oyer
(2004), and Smith and Szymanski (1995).
This paper examines a longitudinal sample of UK companies that offers an
empirical insight into the workings of the executive labour market and permits
direct observation of: the extent to which executives do move jobs –not only
within companies but also between companies; the increase in the likelihood
of an executive switching companies if ‘underpaid’; and the extent to which
an external job move is more or less rewarding than an internal move. The
analysis of this documented labour market activity presents a challenge to
1
Since 2013 in the UK, The Directors’ Remuneration Report from the remuneration com-
mittee is subject to an advisory vote on the implementation and outcomes of the company’s
remuneration policy in the year just ended, and at least once every three years to a separate
binding vote on the company’s executive remuneration policy.
400 IAN GREGORY-SMITH AND BRIAN G. M. MAIN
Scottish Journal of Political Economy
©2015 Scottish Economic Society
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