Executive Compensation Continues to Converge on “One-Size-Fits-All Model”
January 30, 2021
The structure of executive pay packages has become significantly more homogenous since 2006, with 25% of the compensation variation among firms disappearing in the last ten years, according to a new paper by Luis Felipe Cabezon of the USC Marshall School of Business. The paper, titled “Executive Compensation: The Trend Toward One Size Fits All,” looked at over 2000 firms in the S&P 1500 and found that convergence in executive pay has increased every year since 2006. The findings were robust to a variety of factors such as industry, size, company performance, or age of company.
The gradual homogenization of pay is a phenomenon that has concerned experts in the executive compensation space for years. 2006 was a meaningful year for many reasons, including a mandate that companies expense options, new SEC disclosure rules, and the beginnings of what would eventually become Say on Pay. Cabezon’s paper notes the tremendous impact of proxy advisory firms on investor voting, Say on Pay outcomes and, by extension, company pay plans and found that companies with annual Say on Pay voting converge faster than those with triennial voting. Citing studies noting that “boards feel pressure to conform to proxy advisors’ preferences despite their own preferred compensation philosophies,” the paper found that “the compensation structure of all firms is converging to the simulated vector that ISS most recommends to vote in favor of.”
As to the economic consequences of homogenization of pay, the study found that pay actually increases with homogenization while pay sensitivity to performance decreases (likely because pay for performance vehicles are added to existing pay structures such as salary and restricted stock grants without reducing salaries.) The paper also found a negative association with risk-taking behavior and company innovation, hypothesizing that homogenization of pay leads to convergence of strategy (and less risk-taking by executives) which might not be optimal.
Overall, the paper is an interesting contribution to the ever-growing body of research on executive pay, and in particular, the growing influence of proxy advisory firms directly on company pay strategies through the conduit of Say on Pay.