CEO compensation contract homogeneity among industry peers

Abstract

This paper examines the similarity of firms’ CEO compensation contracts among industry peers. We find that although the practice of adopting CEO compensation contracts similar to industry peers is consistent with optimal contracting theory under certain circumstances, there is significant costs to such practice motivated by management entrenchment. Rather than focusing on individual contractual components such as performance measure choices or risk-sharing arrangement, we study the overall compensation contract structure. We construct our measure of CEO compensation contract homogeneity using distance measures based on a comprehensive set of contract elements derived from firms’ proxy statements. Our study indicates that, firms tend to adopt CEO compensation contracts that are more similar to the industry practice when sharing more common risks or common investors with other firms in the same industry, consistent with the predictions under optimal contracting theory. We also find board of directors’ ability to communicate and obtain inside information contribute to compensation structure homogeneity unexplained by general CEO/firm specific characteristics, consistent with inefficient contracting. Last, we find evidence that CEO compensation structure homogeneity is associated with excessive CEO pay and has a negative impact on shareholders’ wealth in the subsequent period.