Abstract
We investigate the impact of CEO networking on compensation arrangements. Unlike existing studies that are largely based on board interlocks, we use a unique measure that calculates the direct ties the CEO has created during her life. We show that a CEO’s compensation is significantly affected by her power in the managerial labour market. We find that the size of the CEO network is positively related to the level of CEO compensation and inversely related to its pay-performance sensitivity. We interpret our results as direct evidence that managerial power influences compensation. However, in firms where shareholders rights are well protected, the impact of the CEO network over pay arrangements diminishes. This implies that outrage cost and governance reduces managerial power in pay negotiation. Overall, our results are consistent with the predictions of the managerial power approach.
This is a preview of subscription content, log in via an institution to check access.
Access this chapter
Tax calculation will be finalised at checkout
Purchases are for personal use only
Notes
- 1.
It is also acknowledged friends and social networks may influence decisions by many of the world’s companies regarding with whom and how they conduct their business (Jackson 2005).
- 2.
Strong social ties link individuals who are similar and the more similar the individuals the stronger the social ties (Wegener 1991). Weak ties comprise acquaintances with whom we are less likely to be socially acquainted whereas a strong tie implies the individuals are close friends (Granovetter 1983). The issue of strong and weak ties is discussed in more detail in following sections.
- 3.
See Wellman (1983) for a detailed explanation of the principles of network theory.
- 4.
If Director “A” sits on a board with “B” and if director “B” sits on a board with “C” then “A” is assumed to know “C” and this link is included to the measure (Larcker et al. 2006). Whether A and C actually know each other, which will allow them to exchange information, know-how etc., is not examined. Larcker et al. (2006) fail to acknowledge this potential bias in their measure.
- 5.
- 6.
For all types of activities, apart from education, BoardEx collects data on the ties developed through board membership. Therefore even for social activities the links for the individual will be counted if she has an active role, e.g. board member of a golf club, trustee of a charitable organization.
- 7.
One expects older CEOs to be more affected by the strength-of-link issue, since some of their ties might date many years back. In our sample though the mean/median CEO age is only 55 years old, with only 1 % of the observations above 70. In any case, we control in our all analyses for CEO age.
- 8.
Here we refer to efficiency wages. Firms are willing to offer to specific key employees compensation which is higher than the market rate in order to reduce employee turnover.
- 9.
Cohen et al. (2009) are the first to use BoardEx data to study the effect of networks in a financial economics context. They find that security analysts gather superior information about firms when they have educational links with the firms’ senior managers.
- 10.
The transformation into CDFs allows us to control for extreme outliers and also facilitates the subsequent analysis on pay-performance sensitivity by helping us readily interpret the estimated coefficients in an economically meaningful way for the way in which CEO network affects the pay sensitivities at any size of the social network (Milbourn 2003, p. 253).
- 11.
The g-index is that published for 2004. This variable is updated on a bi-annual basis and hence the 2004 g-index is the appropriate measure to use with 2005 data. A firm’s corporate governance policy is not expected to change substantially on an annual basis.
- 12.
For example, the first figure in panel D ($18.30) is calculated using the panel B, model 4 coefficients in the following way: 25.13–0.5 × 4.34 + 0.5 × 8.65 + 0.5 × 5.68–0.5 × 3.19–0.5 × 20.46 (we don’t take into account the coefficient for CEO networking since we calculate this figure for the lowest CEO network). The difference between the first and third figure (where we assume maximum CEO networking) stems from the size of coefficient β 2 (the coefficient of the interacted variable: dollar return × CEO Networking).
- 13.
We do not use the actual number of current ties because they are bound to be correlated with the networking measure (i.e. they are part of our networking measure).
- 14.
The correlation coefficient between board size and CEO networks is 21 %. Therefore board size explains 4.4 % (R 2 = ρ 2 = 0.212) of the CEO networking variation.
References
Aggarwal, R., & Samwick, A. (1999). The other side of the trade-off: The impact of risk on executive compensation. Journal of Political Economy, 107, 65–105.
Barnea, A., & Guedj, I. (2006). But, mom, all the other kids have one! CEO compensation and director networks. McCombs School of Business Working Paper, University of Texas at Austin.
Battu, H., Seaman, P., & Zenou, Y. (2011). Job contact networks and the ethnic minorities. Labour Economics, 18, 48–56.
Bebchuk, L. A., & Fried, J. M. (2003). Executive compensation as an agency problem. Journal of Economic Perspectives, 17, 71–92.
Bebchuk, L. A., & Fried, J. M. (2004). Pay without performance: The unfulfilled promise of executive compensation. Cambridge: Harvard University Press.
Bebchuk, L. A., Fried, J. M., & Walker, D. I. (2002). Managerial power and rent extraction in the design of executive compensation. The University of Chicago Law Review, 69, 751–846.
Berle, A., & Means, G. (1932). The modern corporation and private property. New York: Commerce Clearing House.
Burns, J., Godlonton, S., & Keswell, M. (2010). Social networks, employment and worker discouragement: Evidence from South Africa. Labour Economics, 17, 336–344.
Calvo-Armengol, A., & Jackson, M. O. (2007). Networks in labor markets: Wage and employment dynamics and inequality. Journal of Economic Theory, 132, 27–46.
Cohen, L., Frazzini, A., & Malloy, C. (2010). Sell-side school ties. Journal of Finance, 65, 1409–1437.
Constant, D., Sproull, L., & Kiesler, S. (1996). The kindness of strangers: On the usefulness of weak ties for technical advice. Organization Science, 7, 119–135.
Core, J., & Guay, W. R. (2002). The other side of the trade-off: The impact of risk on executive compensation: A revised comment. Working paper. Available at SSRN: http://ssrn.com/abstract=292955.
Core, J., Holthausen, R. W., & Larcker, D. F. (1999). Corporate governance, CEO compensation and firm performance. Journal of Financial Economics, 51, 317–406.
Core, J., Guay, W., & Larcker, D. F. (2003). Executive equity compensation and incentives: A survey. Economic Policy Review, 27–50 Apr 2003.
Demsetz, H., & Lehn, K. (1985). The structure of corporate ownership: Causes and consequences. Journal of Political Economy, 93, 1155–1177.
Fich, E., & White, L. (2003). CEO compensation and turnover: The effects of mutually interlocked boards. Wake Forest Law Review, 38, 935–959.
Fontaine, F. (2008). Why are similar workers paid differently? The role of social networks. Journal of Economic Dynamics & Control, 32, 3960–3977.
Fracassi, C. (2009). Corporate finance policies and social networks. Working Paper, University of Texas at Austin.
Fracassi, C., & Tate, G. A. (2012). External networking and internal firm governance. Journal of Finance, 67, 153–194.
Gompers, P. A., Ishii, J. L., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118, 107–155.
Granovetter, M. (1973). The strength of weak ties. American Journal of Sociology, 78, 1360–1380.
Granovetter, M. (1974). Getting a job: A study of contacts and careers. Cambridge: Harvard University Press.
Granovetter, M. (1983). The strength of weak ties: A network theory revisited. Sociological Theory, 1, 201–233.
Granovetter, M. (2005). The impact of social structure on economic outcomes. Journal of Economic Perspectives, 19, 33–50.
Gulati, R., & Westphal, J. D. (1999). Cooperative or controlling? The effects of CEO-board relations and the content of interlocks on the formation of joint ventures. Administrative Science Quarterly, 44, 473–506.
Hall, B. J., & Liebman, J. B. (1998). Are CEOs really paid like bureaucrats? Quarterly Journal of Economics, 113, 653–691.
Hallock, K. (1997). Reciprocally interlocking boards of directors and executive compensation. Journal of Financial and Quantitative Analysis, 32, 331–344.
Himmelberg, C., Hubbard, G., & Palia, D. (1999). Understanding the determinants of managerial ownership and the link between ownership and performance. Journal of Financial Economics, 53, 353–384.
Horton, J., Millo, Y., & Serafeim, G. (2009). Paid for connections or too connected to be good? Social networks and executive and non-executive directors compensation. Working Paper, London School of Economics.
Hwang, B. H., & Kim, S. (2009). It pays to have friends. Journal of Financial Economics, 93, 138–158.
Ioannides, Y. M., & Loury, L. D. (2004). Job information networks, neighborhood effects, and inequality. Journal of Economic Literature, 42, 1056–1093.
Jackson, M. O. (2005). The economics of social networks. In R. Blundell, W. K. Newey, T. Persson (Eds), Advances in economics and econometrics: Theory and applications, vol. 1, Ch. 1, Ninth World Congress.
Jensen, M., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 4, 305–360.
Jensen, M., & Zajac, A. J. (2004). Corporate elites and corporate strategy: How demographic preferences and structural position shape the scope of the firm. Strategic Management Journal, 25, 507–524.
Larcker, D., Richardson, S., Seary, A., Tuna, I. (2006). Director networks, executive compensation, and firm performance. Working Paper, Stanford University.
Milbourn, T. (2003). CEO reputation and stock-based compensation. Journal of Financial Economics, 68, 233–262.
Mirrlees, J. (1976). The optimal structure of incentives and authority within an organization. Bell Journal of Economics, 7, 105–131.
Mortensen, D. T., & Vishwanath, T. (1994). Personal contacts and earnings: It is who you know! Labour Economics, 1, 187–201.
Murphy, K. J. (1999). Executive compensation. In O. Ashenfelter & D. Card (Eds.), Handbook of labor economics (pp. 2485–2563). North-Holland: Elsevier Science. 3b, Ch. 38.
Nguyen, B. D. (2012). Does the Rolodex matter? Corporate Elite’s small world and the effectiveness of boards of directors. Management Science, 58, 236–252.
Paredes, T. (2005). Too much pay, too much deference: Behavioral corporate finance, CEOs, and corporate governance. Florida State University Law Review, 32, 673–762.
Rogers, E. M. (1995). Diffusion of innovations (4th ed.). New York: Free Press.
Smith, C., & Watts, R. (1992). The investment opportunity set and corporate financing, dividends, and compensation policies. Journal of Financial Economics, 32, 263–292.
Strahilevitz, L. J. (2005). A social networks theory of privacy. The University of Chicago Law Review, 72, 919–988.
Wegener, B. (1991). Job mobility and social ties: Social resources, prior job, and status attainment. American Sociological Review, 56, 60–71.
Wellman, B. (1983). Network analysis: Some basic principles. Sociological Theory, 1, 155–200.
Zhao, Y., & Renneboog, L. (2011). Us knows us in the UK: On director networks and CEO compensation. Journal of Corporate Finance, 17, 1132–1157.
Author information
Authors and Affiliations
Corresponding author
Editor information
Editors and Affiliations
Rights and permissions
Copyright information
© 2012 Springer-Verlag Berlin Heidelberg
About this chapter
Cite this chapter
Brown, R., Gao, N., Lee, E., Stathopoulos, K. (2012). What Are Friends for? CEO Networks, Pay and Corporate Governance. In: Boubaker, S., Nguyen, B., Nguyen, D. (eds) Corporate Governance. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-31579-4_12
Download citation
DOI: https://doi.org/10.1007/978-3-642-31579-4_12
Published:
Publisher Name: Springer, Berlin, Heidelberg
Print ISBN: 978-3-642-31578-7
Online ISBN: 978-3-642-31579-4
eBook Packages: Business and EconomicsBusiness and Management (R0)