Armstrong Et Al 2012

Rev Account Stud (2012) 17:322351
DOI 10.1007/s11142-012-9182-y
Corporate governance, compensation consultants,

and CEO pay levels
Christopher S. Armstrong Christopher D. Ittner
David F. Larcker
Published online: 9 March 2012

Springer Science+Business Media, LLC 2012
Abstract This study investigates the relation between corporate governance and
CEO pay levels and the extent to which the higher pay found in firms using com-
pensation consultants is related to governance differences. Using proxy statement
disclosures from 2,110 companies, we find that CEO pay is higher in firms with
weaker governance and that firms with weaker governance are more likely to use
compensation consultants. CEO pay remains higher in clients of consulting firms
even after controlling for economic determinants of compensation. However, when
consultant users and non-users are matched on both economic and governance
characteristics, differences in pay levels are not statistically significant, indicating
that governance differences explain much of the higher pay in clients of compen-
sation consultants. We find no support for claims that CEO pay is higher in
potentially conflicted consultants that also offer additional non-compensation-
related services.
Keywords Equity incentives Corporate governance Executive compensation

Compensation consultants
JEL Classification G30 G34 M12 M52 M55
C. S. Armstrong C. D. Ittner (&)

The Wharton School, University of Pennsylvania, 1300 Steinberg-Dietrich Hall, Philadelphia,
PA 9104, USA
e-mail: Ittner@wharton.upenn.edu
C. S. Armstrong
e-mail: carms@wharton.upenn.edu
D. F. Larcker
Graduate School of Business, Rock Center for Corporate Governance, Stanford University,
655 Knight Way, Stanford, CA 94305, USA
e-mail: Larcker_David@gsb.stanford.edu
123
Corporate governance 323
1 Introduction
The relation between chief executive officer (CEO) pay levels and corporate
governance has received considerable attention. Critics charge that CEOs of firms
with weak corporate governance can extract pay in excess of that justified by the
firms economic characteristics because they control the pay-setting process and
have board members without the knowledge or incentives needed to reject excessive
pay proposals (for example, Bebchuk and Fried 2003, 2004; Morgenson 2006a;
Anderson et al. 2007; U.S. House of Representatives 2007). These claims are
supported by empirical studies finding that CEO pay is greater than predicted by
economic determinants when the CEO is more powerful and corporate governance
is weak (for example, Lambert et al. 1993; Borokhovich et al. 1997; Conyon and
Peck 1998; Daily et al. 1998; Core et al. 1999; Cyert et al. 2002; Faleye 2007).
A key question raised by these results is how CEOs justify excess pay levels to
their boards of directors, shareholders, and outside observers. One potential
mechanism is through the use of compensation consultants. A wide range of
business leaders, academics, and politicians charge that CEOs of companies with
weak governance use compensation consultants, who are beholden to clients for
current and future business, to design and justify excessive pay packages (for
example, Crystal 1991; Bebchuk and Fried 2004; Buffett 2007; U.S. House of
Representatives 2007). These claims have prompted increased compensation
disclosure requirements and political investigations. The Securities and Exchange
Commission, for example, requires proxy statements filed on or after Dec. 15, 2006,
to disclose which, if any, consultants provide compensation advice to the company.1
A number of studies provide evidence that CEO pay levels are higher than
predicted by economic determinants in firms that use compensation consultants (for
example, Corporate Library 2007; Murphy and Sandino 2008; Conyon et al. 2009;
Cadman et al. 2010). However, these studies provide relatively little evidence
regarding why pay is higher in consulting clients. Although consultants can provide
advice on executive pay packages, the ultimate responsibility for setting and
approving pay levels rests with the board of directors. In the absence of weak
governance structures that allow CEOs to extract excess pay, there is no clear
reason why pay levels should be higher in consulting clients. Moreover, if firms
with weak governance are more likely to use compensation consultants, and
governance characteristics are not sufficiently incorporated into the analyses, then
any conclusions about what is driving the excess pay levels may be inappropriate.
We conduct an analysis of the influence of compensation consultants on the link
between corporate governance and CEO pay using proxy disclosures by a diverse
sample of 2,110 companies. Consistent with prior studies, we find that executive pay
1
Regulation S-X 407 (e) (3) (iii) states that companies are required to provide a narrative description
of any role of compensation consultants in determining or recommending the amount or form of
executive and director compensation, identifying such consultants, stating whether such consultants are
engaged directly by the compensation committee (or persons performing the equivalent functions) or any
other person, describing the nature and scope of their assignment, and the material elements of the
instructions or directions given to the consultants with respect to the performance of their duties under the
engagement.
123
324 C. S. Armstrong et al.
levels are higher than predicted by economic characteristics in firms with weaker
governance and in firms using compensation consultants. We also find that firms
with weaker governance are more likely to use consultants. When we employ
propensity score matched pair analyses to match firms on both economic and
governance characteristics, we find no significant difference in total pay levels
between consultant users and non-users.2 This evidence indicates that two
economically similar firms with equally weak governance structures are both likely
to exhibit similar higher-than-predicted pay levels, regardless of their use or non-use
of consultants. These findings suggest that governance differences account for much
of the unexplained pay differences between consultant users and non-users. Finally,
we find no evidence that our results are driven by differences between clients of
potentially conflicted consultants who offer a broad range of advisory services
relative to clients of specialized, non-conflicted compensation consulting firms,
providing no support for claims that consultants with potential conflicts of interest
are more likely to facilitate the extraction of excess CEO pay in firms with weak
governance.
The remainder of the study is organized as follows. Sect. 2 reviews the prior
literature on governance arguments for differences in total CEO pay levels in
companies using or not using compensation consultants. Sect. 3 discusses our
sample and variables. Sect. 4 provides results. Sect. 5 concludes.
2 Literature review
2.1 CEO pay, governance, and compensation consultants
Economic theory (along with the pay justifications included in the majority of
annual proxy statements) suggests that executive pay packages are designed to
efficiently achieve attraction, retention, and incentive objectives. This efficient
contracting view of compensation plan design maintains that any differences in
pay levels across firms are due to differences in economic characteristics that affect
these objectives. Consistent with this view, empirical studies have identified a wide
variety of economic factors that are associated with pay differentials (see Murphy
1999 and Prendergast 1999 for reviews).
In contrast, critics of the pay-setting process charge that CEO pay packages are
not always in shareholders best interests. Managerial power theories contend
that CEOs have a great deal of power or control over the board of directors and that
CEOs use this power to extract excess pay levels that are larger than economic
characteristics justify (for example, Allen 1981; Bebchuk and Fried 2003, 2004). A
number of factors are claimed to influence the CEOs power over the board,
2
Propensity score matching is robust to misspecification of the functional form linking CEO
compensation to selected determinants and allows us to assess the impact of the endogenous choice of
compensation consultants on the results. See Rosenbaum (2002) and Rosenbaum and Rubin (1983) for
theoretical background and Armstrong et al. (2010) for a detailed explanation of propensity score
matching in compensation research and an application examining whether equity incentives motivate
managers to engage in accounting manipulations.
123
including the executives ability to support the nomination and retention of

directors, the presence of company employees (or insiders) on the board, and
joint dealings between the CEO and the directors firms, among others (for example,
Crystal 1991; Bebchuk and Fried 2003, 2004). These factors, together with many
directors lack of incentives, skills, or available time to adequately scrutinize
proposed CEO pay packages, give CEOs in firms with weak governance
considerable influence over the pay-setting process and compensation outcomes.
Consistent with these managerial power theories, empirical studies have found a
variety of governance characteristics (such as the CEOs appointment of board
members, board of directors characteristics and rules, and shareholder rights) related
to CEO pay levels, with weaker governance associated with greater excess pay (for
example, Lambert et al. 1993; Borokhovich et al. 1997; Conyon and Peck 1998;
Daily et al. 1998; Core et al. 1999; Cyert et al. 2002; Faleye 2007).
Bebchuk and Fried (2003, 2004) argue that one constraint on powerful CEOs pay
levels is the ability to implement pay packages that can plausibly be defended and
justified to board members, shareholders, and outside observers, thereby avoiding the
outrage costs associated with pay levels that are deemed to be too high. Numerous
executive compensation critics claim that compensation consultants provide an
important mechanism for this justification (for example, Crystal 1991; Bebchuk and
Fried 2003, 2004; Morgenson 2006a; Anderson et al. 2007; U.S. House of
Representatives 2007). The majority of large U.S. companies engage compensation
consultants to provide assistance in the design of executive compensation contracts.
This assistance can range from the simple provision of benchmarking data on pay
practices in other companies to advice on the structure and level of executive
compensation and the tax, legal, and accounting implications of pay packages.
Although some consultants focus solely on the provision of compensation advice,
others offer a broad range of services such as pension and benefit administration,
actuarial services, and advice on other human resources management practices.
Critics charge that consultants have strong incentives to help inflate CEO pay to
ensure future business. According to the chairman of the New Jersey Investment
Council: The theoretical role of the compensation consultant is to make an
independent assessment of what senior executives are supposed to be paid. The
business model of being a compensation consultant is based on satisfying the
interests of the people about whom theyre supposed to be making that independent
judgment.3 For example, consultants who are beholden to powerful CEOs for
business (either ongoing compensation advice or other services) can use proprietary
compensation surveys to justify high CEO pay levels by selectively choosing the
peer group for benchmarking purposes (Crystal 1991; Buffett 2007).4 As one SEC
3
Journal of Corporate Law (2005). Beginning in 2004, NYSE and NASDAQ rules required all or nearly
all members of the boards compensation committee to be independent (that is, not an officer or
employee of the company or a family member of such a director). However, if these independent
directors owe their positions, future opportunities, or pay levels to the CEO, their compensation decisions
may still be influenced by the CEOs power over the board (Bebchuk and Fried 2004; Campos 2007).
4
See Conyon et al. (2009), Cadman et al. (2010), and Murphy and Sandino (2010) for studies examining
the association between CEO pay practices and the provision of additional (noncompensation) services by
consultants, and Goh and Gupta (2010) for research on compensation consultant opinion-shopping.
123
commissioner noted, It is extremely difficult to avoid using high comparables, and

consultants can pretty much find high comparable income data to support paying a
high amount to the CEO. This is the case even if the consultant reports directly to
the board (Campos 2007). Proponents of managerial power theories argue that
consulting practices such as these provide a mechanism for CEOs with significant
influence over the board of directors to justify excessive pay packages.
A primary assumption in this literature is that weak corporate governance and
excess CEO pay are not in shareholders best interests. However, lower
governance costs may offset higher compensation costs. Recent theoretical research
suggests that strict corporate governance can be suboptimal because of the tradeoffs
between the boards dual roles as advisors and monitors. If monitoring is too strict,
CEOs may not share information that would be beneficial in the boards advisory
role in an effort to avoid more intensive monitoring (Adams and Ferreira 2007),
may avoid investments that may be perceived as manager-specific even if the
investment is in the shareholders interests (Almazan and Suarez 2003), and may
withhold private information on their abilities that the board needs in deciding
whether a CEO should be replaced (Laux 2008). Consequently, in some
circumstances it may be in shareholders best interest to employ weaker boards
that lack some independence. A similar argument can be made in the current
settingnamely, that weaker corporate governance, which may be optimal, reduces
the boards ability to internally generate a benchmark for evaluating CEO
performance and compensation. This situation creates a demand in these firms for
compensation consultants to establish a suitable benchmark.
Given the potential interdependencies among governance practices, compensa-
tion policies, and the use of compensation consultants, we make no assumptions
regarding the optimality or sub optimality of these choices. Instead, we focus on the
more basic questions of whether corporate governance plays any role in the
observed relation between compensation consultants and CEO pay levels.
2.2 Related research
Despite the growing popular, legal, and political backlash against CEO pay levels
and perceived corporate governance failures, along with criticisms of compensation
consultants role in setting and justifying executive pay packages (for example,
Morgenson 2006a, b, 2008; Frank 2007; Piore 2007; U.S. House of Representatives
2007), relatively little evidence exists on the extent to which the higher pay levels
observed in compensation consultant clients are a manifestation of weaker
governance. What evidence that does exist is mixed. Consistent with claims that
consultants are used strategically to justify high pay, Wade et al. (1997) find that
companies with larger CEO salaries and bonuses are more likely to cite consultants
when rationalizing pay levels to shareholders, but the authors do not examine
whether these results are influenced by governance characteristics. Bizjak et al.
(2008) and Faulkender and Yang (2010) examine whether peer groups are
selectively chosen by companies with weak governance to extract excess pay. While
Bizjak et al. (2008) conclude that peer-group benchmarking is related more to
economic factors than to weak governance, Faulkender and Yang (2010) conclude
123
that CEOs of companies with weak governance choose peer groups that generate
higher compensation. Neither study examines the role of compensation consultants
in the choice of peer groups.
In the studies most closely related to ours, Conyon et al. (2009), Cadman et al.
(2010), and Murphy and Sandino (2010) examine the association between
compensation consultants and executive pay. Both Conyon et al. (2009) and
Cadman et al. (2010) find that total CEO pay is higher than predicted by economic
determinants in consulting clients but find no evidence that the higher pay is
associated with their limited set of proxies for corporate governance (CEO tenure
and average board member tenure). Murphy and Sandino (2010), in turn, examine
CEO pay levels in a sample of compensation consultant users. Two of their three
CEO influence variables (an indicator for whether the CEO is also chairman of
the board and the percentage of directors the CEO appointed but not the percentage
of non-independent directors) are positively associated with CEO pay in U.S. firms
but not Canadian firms. However, they find higher CEO pay when the compensation
consultant works for the board rather than for management, which is inconsistent
with their prediction that consultants working for the board are more independent
and will recommend lower pay levels. Murphy and Sandino (2010) do not examine
differences between compensation consultant users and non-users.
Given this limited evidence and the increasing attention on the influence of
corporate governance and compensation consultants on CEO pay levels, we extend
prior compensation and governance studies to examine whether compensation
consultant use is associated with weaker governance and, if so, whether weaker
governance explains the observed relation between consultant usage and higher
CEO pay.
3 Sample and variable measurement
Our sample consists of 2,110 publicly traded companies with (1) fiscal years ending
on or after Dec. 31, 2006 (thereby falling under the new disclosure requirements),
that filed their annual proxy statements (DEF 14A) as of Dec. 14, 2007, and (2)
available data for the variables used in our analyses. These companies are primarily
in the Russell 3000, but we also include select smaller companies meeting these
criteria. This sample is broadly representative of corporations in the economy and
consists of considerably more firms than the samples in other compensation
consultant studies.
3.1 Compensation consultant use
Data on the use and identity of compensation consultants are collected from the
compensation committee report in the companies first proxy statement following
the introduction of the new disclosure rules. In most cases, the primary consultant is
clearly identified in the text of the proxy. If no consultant is discussed, we classify
the company as not using a consultant. In instances in which multiple consultants
123
are listed, we code the consultant the company used for senior executive-
compensation advice.5
In our sample, 87.60% use consultants for compensation advice, and 95 different
consulting firms are employed, with nine consultants engaged by more than 40
companies. The most frequently used consultant is Towers Perrin (12.24% of the
sample), followed by Mercer (11.07%), Frederic Cook (8.96%), Hewitt (8.11%),
Watson Wyatt (5.42%), Pearl Meyer (4.80%), Radford (2.64%), Compensia
(2.47%), and Hay (2.33%). The remaining companies use a wide variety of different
consulting firms, most of which are small boutique compensation consultants.
3.2 Compensation
Given the focus on total pay levels in recent debates over executive compensation,
we examine the CEOs total annual compensation. Total annual compensation is
defined as the sum of salary, actual bonus, target long-term incentive plan payments,
pension contributions and other perquisites, the BlackScholes value of stock option
grants, and the market value of restricted and unrestricted stock grants. As is
common in executive compensation studies (for example, Core and Guay 1999), we
apply a time discount of 0.70 to option maturity when calculating the options
BlackScholes value to account for the prevalence of early option exercises. Annual
compensation in our sample ranges from $0 to $91,375,384, with a mean (median)
of $4,974,377 ($2,703,304). Similar to most executive compensation studies, we use
the natural logarithm of this number in our analyses because of the highly (right)
skewed distribution of pay.
The level of expected compensation may be influenced by the mix of pay between
relatively fixed components such as salary, benefits, and short-term bonuses and
riskier long-term variable pay components such as stock options, restricted stock, and
performance units. Economic theory indicates that expected pay levels must be higher
when pay is riskier to compensate the executive for the additional risk. Similar to Core
et al. (1999) and Murphy and Sandino (2008), we control for the risk-premium due to
additional compensation risk by including Pay Mix as a control variable in our tests.
This variable is calculated as the ratio of long-term variable pay (stock options,
restricted stock, and performance units) to total compensation.6
5
A common example of multiple consultants is an instance in which one consulting firm provides
compensation advice for senior executives and another provides advice for lower-level management.
6
Our results are similar if we include bonuses in the numerator to get a more inclusive measure of
variable pay. As noted above, we examine total CEO pay levels because they have been the primary focus
of recent CEO compensation debates. However, if Pay Mix is capturing differences in consultant use and
governance, its inclusion will bias us against finding pay level differences due to these two factors. To
examine this possibility, we repeated our analyses using Pay Mix as the dependent variable in place of
CEO pay level. We find mixed governance results in a regression of Pay Mix on the economic and
governance variables discussed later in the paper (model adjusted R2 = 18.7%). Pay Mix is positively
associated with the percentage of old board members and negatively associated with the percentages of
busy board members and board members who are outsiders. The busy board result is inconsistent with
higher Pay Mix in firms with weaker governance. In propensity scoring matched pair analysis, we find
significantly higher Pay Mix in consultant users when only economic characteristics are included in the
analyses but no significant pay differences when both economic and governance characteristics are
included.
123
3.3 Economic determinants
Consistent with prior theoretical and empirical compensation research, we include

variables to capture potential economic determinants of CEO pay. Studies indicate
that CEO compensation levels should increase with firm size, operating and stock
price performance, and investment opportunities (for example, Murphy 1999;
Lambert and Larcker 1987; Smith and Watts 1992; Core and Guay 1999). We
measure firm size using Log (Market Cap), which equals the natural logarithm of
the firms market capitalization at the beginning of the fiscal year.
Several variables are employed to capture operating and stock price performance.
Previous studies suggest that two elements of operating performance matter in
assessing executive pay levels. First, operating performance in the previous year
provides a reasonable estimate of expected performance in the current year, which is
likely to influence the target pay levels companies set. Second, changes in operating
performance during the period determine actual bonus payouts and other variable pay
elements that are based on the periods operating performance. We therefore use two
variables to measure operating performance. Return on Assets is the companys net
income in the prior year (Compustat element NI), scaled by the average of beginning-
and end-of-year total assets (average of Compustat element AT for the two dates).
Change in Return on Assets is the change in Return on Assets in the current year. We
also include stock price performance over the prior two prior years, denoted Prior
Return (-1) and Prior Return (-2), respectively. The two return measures allow for
the possibility that boards exhibit lags in their CEO pay decisions.
Similar to prior studies, we use the Book-to-Market ratio as an inverse measure of
the companys investment opportunities. Book-to-Market equals the book value of
the firms total assets scaled by market capitalization, both measured at the
beginning of the fiscal year. Lower book-to-market ratios are expected to reflect
greater investment opportunities, since much of the markets valuation of the
company (along with future cash flows) reflects factors that are not captured in the
book value of the companys assets.
CEO-specific characteristics may also influence compensation levels. For
example, pay is likely to be higher for more experienced CEOs. We use three
variables to capture CEO experience: CEO Tenure (number of years the CEO has
held the title of chief executive officer), CEO Age (age of the CEO in years), and
New CEO (an indicator equal to one if the CEO was appointed to this position
during the fiscal year). The New CEO variable is included because firms often
provide relatively large compensation packages in the first year of a CEOs tenure to
establish a certain level of equity incentives and to make the CEO whole with
respect to any compensation forfeited from his or her prior employer.7
7
New CEOs may also use talent agents or executive placement firms to help them negotiate new pay
packages. For example, using a propensity score matched pair research design, Rajgopal et al. (2011) find
that CEOs who use talent agents receive initial pay that is higher than predicted by either economic or
governance characteristics, a result that does not persist after the initial year. Given the potential
differences in the pay-setting practices used for new CEOs, we also conducted our tests after dropping the
252 firms with new CEOs in our sample. The only significant difference was that a variable capturing the
use of dual-class voting shares became insignificant in a regression of pay levels on economic and
123
CEOs may have other economic incentives that substitute for annual pay. To
control for the CEOs existing equity incentives, we include the variable Portfolio
IV, which equals the natural logarithm of one plus the intrinsic value of the CEOs
equity portfolio of stock, restricted stock, and option holdings (both vested and
unvested). There are two possible pay outcomes associated with equity incentives. If
the CEOs existing equity incentives and total wealth are high, there may be little
reason to provide additional incentives using annual compensation, and compen-
sation levels may be lower. In contrast, if the equity incentives provide the CEO
with considerable power over the board, we may observe higher annual
compensation. Finally, we include Founder CEO (an indicator that equals one if
the current CEO is one of the companys founders) since company founders may
have incentives other than maximizing pay.
3.4 Governance measures
Prior studies linking corporate governance to compensation practices have typically

examined two broad categories of governance constructs: (1) board of director
characteristics and (2) board charter rules. We proxy for these constructs using
board of directors data from the Equilar analysis of proxy statements and board rules
data from FactSet SharkRepellent.
Consistent with earlier studies, we use six variables to capture board character-
istics. Yermack (1996) and Coles et al. (2008) find that board size negatively
influences managerial and board decision-making. We therefore measure Number of
Directors as the natural logarithm of the number of directors on the board, which
accounts for skewness in the number of directors. Our next five variables assess
board characteristics that Core et al. (1999), Fich and Shivdasani (2006), and others
find associated with excess CEO compensation. (1) % Outside Directors is the
percentage of board members classified as outsiders.8 (2) % Board Old is the
percentage of board members who are at least 69 years old. (3) % Board Busy is the
percentage of board members who serve on at least two boards of directors. (4)
Outside Chairman is an indicator that equals one if the chairman of the board is
classified as an outsider and zero otherwise (where outsiders are not involved in the
management of the company and have no substantial business dealings with the
company). And (5) % Outsider Apptd. by CEO is the percentage of board members
classified as outsiders who were appointed after the current CEOs term began.
Following Core et al. (1999) and other governance studies, we expect stronger board
governance to be positively related to Outside Chairman and % Outside Directors
and negatively related to the other board characteristic variables.
Footnote 7 continued
governance variables. However, the models adjusted R2 remained nearly identical. Our propensity
scoring models and matched pairs tests of pay levels between consultant users and non-users exhibit no
significant changes when these observations are removed, suggesting that the inclusion of new CEOs is
not responsible for our results.
8
The definitions of inside and outside board members are consistent with the NYSE definitions used for
listing requirements. These definitions are used in proxy statements and are adopted in our measures.
123
We include two additional variables for board charter rules that activist
shareholder groups and governance research suggest are important indicators of
governance effectiveness. The first is an indicator for whether the companys board
members are all elected annually or are elected to staggered, multiyear terms
(denoted as Staggered Board). Activist shareholders argue that staggered terms
impede shareholders monitoring of the board by making it harder for them to alter
the boards composition over a short period (for example, Daines and Klausner
2001; Gompers et al. 2003). Second, Dual Class equals one if the company has
multiple classes of shares with unequal voting rights. These shares are argued to be
an indicator of weaker governance (Gompers et al. 2003; Wang et al. 2010).
3.5 Industry
In addition to the preceding economic and governance factors, the compensation

literature emphasizes the importance of industry membership for labor market
benchmarking purposes. We follow prior literature and use industry fixed effects to
capture industry-specific differences in compensation levels. These fixed effects
indicators are based on two-digit SIC codes unless there are fewer than 25
observations in the industry, in which case we use one-digit SIC codes.9
3.6 Descriptive statistics
Descriptive statistics for CEO compensation and the economic and governance
variables are presented in Table 1. The table reports tests for differences in means
(one-way ANOVA) and medians (KruskalWallis) for two groups of firms: those
that employ compensation consultants and those that do not. Firms using consultants
tend to have higher market capitalization and higher total pay, as well as a higher
proportion of riskier compensation. CEOs in firms without compensation consul-
tants are more likely to be firm founders and generally have longer tenure. However,
comparisons of the other economic variables are not consistently significant in the
two types of tests.
In contrast, the majority of the governance variables differ across the two
groups. Firms using consultants have more directors, busier board members, and
staggered boards, all of which are claimed to be elements of weaker governance.
Firms not using compensation consultants tend to have older boards and a larger
percentage of outside directors appointed by the CEO, purported to be indicators
of weaker governance. However, the chairmen of their boards and board members
are more likely to be outsiders, which prior studies suggest are signs of stronger
governance.
9
Albuquerque (2009) argues that a combination of industry and size quartile is a stronger peer group for
benchmarking executive compensation than is industry alone. As a robustness check, we conducted the
tests using the Albuquerque measure rather than our industry fixed effects. The results were virtually
identical, with any significant (insignificant) results remaining significant (insignificant) and estimated
coefficients changing little.
123
Table 1 Descriptive statistics for economic and governance covariates by compensation consultant category and full sample
332
Consultant used No consultant used One-way Kruskal

ANOVA Wallis test
123
Mean Median Std. dev. Mean Median Std. dev.
Total annual compensation 5,194,626 2,985,869 6,103,016 2,454,690 1,179,736 3,942,361 0.000 0.000
Pay mix 0.659 0.664 0.264 0.543 0.519 0.218 0.000 0.000
Log (market capitalization) 7.188 7.060 1.644 6.145 5.998 1.614 0.000 0.000
Return on assets 0.017 0.035 0.142 -0.001 0.034 0.191 0.073 0.716
Change in ROA -0.001 0.000 0.128 -0.024 0.001 0.436 0.072 0.970
Book-to-market 0.291 0.410 3.646 0.342 0.380 1.597 0.822 0.534
Prior return (-2) 0.122 0.115 0.231 0.123 0.128 0.307 0.936 0.845
Prior return (-1) 0.160 0.127 0.340 0.155 0.086 0.435 0.835 0.069
CEO tenure 6.591 5.200 5.851 9.466 6.950 8.300 0.000 0.000
CEO age 53.948 54.000 7.125 54.868 54.000 9.112 0.058 0.294
Portfolio IV 80,496,543 23,701,664 159,927,152 88,961,978 20,245,941 178,006,362 0.426 0.130
New CEO 0.123 0.000 0.328 0.109 0.000 0.312 0.523 0.522
Founder CEO 0.097 0.000 0.296 0.184 0.000 0.388 0.000 0.000
Number of directors 9.277 9.000 2.586 7.707 7.500 2.001 0.000 0.000
% Outside directors 0.710 0.727 0.155 0.624 0.625 0.170 0.000 0.000
% Board old 0.115 0.100 0.127 0.161 0.125 0.176 0.000 0.001
% Board busy 0.395 0.400 0.250 0.263 0.222 0.216 0.000 0.000
Outside chairman 0.594 1.000 0.491 0.756 1.000 0.431 0.000 0.000
% Outsider apptd. by CEO 0.633 0.700 0.341 0.729 1.000 0.348 0.000 0.000
C. S. Armstrong et al.
Table 1 continued
Consultant used No consultant used One-way Kruskal
ANOVA Wallis test
Mean Median Std. dev. Mean Median Std. dev.
Staggered board 0.518 1.000 0.500 0.410 0.000 0.493 0.001 0.001
Corporate governance
Dual class 0.076 0.000 0.265 0.105 0.000 0.307 0.102 0.102
This table presents descriptive statistics (mean and median) for sample firms according to whether a compensation consultant was used during the fiscal year. Also reported
are the p value of a one-way ANOVA and KruskalWallis one-way analysis of variance tests across the Consultant Used and No Consultant Used categories. The one-way
ANOVA tests the joint equality of means of each covariate across categories and assumes the covariates are independent, are approximately normally distributed, and have
equal variance. The KruskalWallis one-way analysis of variance is a nonparametric test of the joint equality of medians across categories. Total annual compensation is
the total compensation of the CEO for the fiscal year, which is defined as the sum of salary, actual bonus, target long-term incentive plan payments, pension contributions
and other perquisites, the BlackScholes value of stock option grants (using 70% of the options life), and the market value of restricted and unrestricted stock grants. Pay
Mix is the ratio of long-term variable pay (stock options, restricted stock, and performance units) to total compensation. Log (market capitalization) is the natural logarithm
of the firms market capitalization at the beginning of the fiscal year in millions of dollars. Return on assets is the firms net income scaled by the average of the beginning-
and end-of-year total assets. Change in ROA is the change in the firms return on assets (as previously defined) during the fiscal year. Book-to-market is the book value of
the firms total assets scaled by market capitalization, both measured at the fiscal-year end. Prior return (-2) is the stock price return over the preceding year. Prior return
(-1) is the stock price return over the prior year. CEO Tenure is the number of years the current CEO has held the chief executive officer title. CEO Age is the age of the
current CEO in years. Portfolio IV is the intrinsic value of the CEOs equity portfolio of stock, restricted stock, and option holdings, both vested and unvested. New CEO is
an indicator equal to one if the CEO at the fiscal-year end became the CEO during the fiscal year. Founder CEO is an indicator that takes a value of one if the current CEO
is one of the founders of the firm and zero otherwise. Number of directors is the number of directors on the board. % Outside directors is the percentage of the directors
who are classified as outsiders. Fraction Board Old is the percentage of the members of the board of directors who are at least 69 years old. Fraction of board busy is the
percentage of the members of the board of directors who serve on at least two boards of directors. Outside lead director is an indicator that equals one if the lead director is
classified as an outsider and zero otherwise. Fraction Outsiders apptd. by CEO is the fraction of the members of the board of directors who are classified as outsiders who
were appointed since the CEO took office. Staggered board is an indicator variable that takes a value of one if the firms board of directors is staggered and zero otherwise.
Dual class is an indicator variable that takes a value of one if the firm has multiple classes of shares with differential voting rights and zero otherwise
333
123
334
Table 2 Correlation matrix
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19) (20) (21) (22)
123
(1) Total Annual Compensation 0.38 0.70 0.16 0.02 0.01 0.13 0.04 0.02 0.11 0.41 -0.08 -0.07 0.35 0.19 0.01 0.41 -0.20 0.00 -0.09 0.02 0.16
(2) Pay Mix 0.55 0.38 0.01 -0.03 0.05 0.02 -0.08 -0.11 -0.14 0.11 -0.06 -0.07 0.03 0.16 -0.15 0.36 -0.15 -0.05 0.00 -0.01 0.16
(3) Log(Market Capitalization) 0.78 0.39 0.37 -0.01 0.08 0.21 -0.04 -0.02 0.07 0.42 -0.03 -0.10 0.46 0.21 -0.02 0.47 -0.29 0.00 -0.06 0.02 0.21
(4) Return on Assets 0.23 0.10 0.37 -0.21 0.06 0.43 0.08 0.09 0.09 0.18 -0.08 -0.08 0.12 0.04 0.05 0.05 -0.13 0.09 0.01 0.02 0.04
(5) Change in ROA 0.09 -0.05 0.02 -0.27 -0.01 0.05 0.17 0.00 0.01 0.00 -0.05 -0.01 0.00 0.02 0.01 0.04 -0.04 -0.04 -0.03 -0.01 0.04
(6) Book-to-Market -0.12 -0.21 -0.19 -0.27 -0.01 0.07 -0.03 0.02 0.02 0.01 0.01 0.00 0.02 -0.03 0.00 -0.05 -0.01 0.05 -0.02 -0.02 -0.01
(7) Prior Return (-2) 0.22 0.03 0.23 0.37 0.14 -0.19 0.44 0.09 0.07 0.16 -0.13 -0.02 0.03 0.03 0.07 0.03 -0.04 0.10 -0.02 -0.04 0.00
(8) Prior Return (-1) 0.13 -0.08 0.01 0.01 0.33 0.10 0.46 0.00 0.01 0.07 -0.09 0.00 0.03 -0.02 0.01 0.02 -0.02 0.01 -0.02 0.00 0.00
(9) CEO Tenure 0.00 -0.07 -0.02 0.10 -0.05 -0.07 0.14 0.03 0.33 0.29 -0.38 0.38 -0.08 -0.10 0.13 -0.14 -0.03 0.43 0.00 0.09 -0.16
(10) CEO Age 0.09 -0.12 0.08 0.07 -0.01 0.06 0.05 0.02 0.32 0.15 -0.14 0.03 0.12 -0.01 0.21 0.01 -0.05 0.12 -0.04 0.05 -0.03
(11) Log(Portfolio IV) 0.57 0.28 0.63 0.34 0.03 -0.19 0.34 0.18 0.41 0.15 -0.11 0.18 0.13 -0.05 0.08 0.13 -0.08 0.21 -0.05 0.10 -0.02
(12) New CEO -0.11 -0.07 -0.03 -0.06 -0.04 0.05 -0.14 -0.10 -0.56 -0.14 -0.30 -0.10 -0.01 -0.01 -0.03 -0.01 0.05 -0.28 0.02 0.01 0.02
(13) Founder CEO -0.11 -0.06 -0.10 -0.01 -0.04 -0.09 -0.01 -0.01 0.33 0.01 0.19 -0.10 -0.20 -0.10 -0.01 -0.11 0.03 0.27 0.03 -0.01 -0.11
(14) Number of Directors 0.37 0.06 0.48 -0.02 0.03 0.12 0.05 0.08 -0.07 0.13 0.20 0.00 -0.22 0.05 0.01 0.15 -0.14 -0.05 0.04 0.02 0.21
(15) % Outside Directors 0.26 0.17 0.22 0.04 0.05 -0.01 0.04 0.01 -0.08 0.01 0.05 -0.01 -0.11 0.11 -0.09 0.23 -0.19 -0.19 0.06 -0.14 0.18
(16) % Board Old -0.02 -0.12 -0.01 0.05 -0.01 0.01 0.06 0.03 0.12 0.15 0.06 -0.03 -0.02 0.04 -0.09 -0.14 0.04 0.01 -0.09 0.05 -0.12
(17) % Board Busy 0.51 0.37 0.47 0.12 0.09 -0.16 0.05 0.03 -0.12 0.03 0.27 0.00 -0.11 0.17 0.27 -0.11 -0.19 -0.10 -0.02 -0.04 0.18
(18) Outside Chairman -0.29 -0.14 -0.30 -0.11 -0.04 -0.01 -0.06 -0.04 -0.04 -0.06 -0.23 0.05 0.03 -0.17 -0.18 0.05 -0.20 -0.06 -0.05 0.00 -0.11
(19) % Outsider Apptd. by CEO -0.04 -0.05 -0.02 0.11 -0.08 -0.06 0.07 -0.01 0.47 0.11 0.29 -0.24 0.29 -0.10 -0.24 0.01 -0.12 -0.05 -0.02 0.11 -0.09
(20) Staggered Board -0.04 -0.01 -0.04 -0.01 -0.02 0.03 -0.02 -0.02 0.02 -0.02 -0.05 0.02 0.03 0.05 0.06 -0.09 -0.02 -0.05 -0.02 -0.08 0.08
(21) Dual Class 0.05 0.00 0.03 -0.01 -0.01 0.01 -0.06 0.00 0.05 0.04 0.07 0.01 -0.01 0.01 -0.14 0.05 -0.03 0.00 0.12 -0.08 -0.03
(22) Consultant Used 0.25 0.16 0.22 0.01 0.00 0.01 0.00 0.04 -0.11 -0.01 0.03 0.02 -0.11 0.22 0.18 -0.07 0.18 -0.11 -0.11 0.08 -0.03
This table presents a correlation matrix of the primary variables. Pearson product-moment correlations are reported above the diagonal, and Spearman rank-order
correlations are reported below the diagonal. Correlation coefficients that are statistically significant at the 1% level or less are reported in bold. Consultant used is an
indicator that takes a value of one if a compensation consultant is used and zero otherwise. All remaining variables are defined in the caption of Table 1
C. S. Armstrong et al.
3.7 Correlations
Table 2 reports correlations between our variables. Total annual compensation is

most highly correlated with firm size (market capitalization), followed by the CEOs
existing portfolio value and the ratio of long-term variable pay to total
compensation (Pay Mix). Pay levels are significantly correlated (p \ 0.01) with a
number of the governance variables, including positive associations with the
number of directors, and the percentage of busy board members, and have a
significant negative association with chairmen who are outsiders. These correlations
are consistent with higher CEO pay in firms with weaker boards. Consultant use is
positively correlated with total annual compensation (Pearson r = 0.16, Spearman
r = 0.25) and with all of the governance variables except for dual class shares, with
the signs of the correlations generally suggesting that compensation consultants are
employed in firms with weaker governance.
4 Results
4.1 Economic and governance determinants of CEO pay levels
The univariate tests in Tables 1, 2 suggest that the higher CEO pay levels observed
in consultant users may actually reflect differences in corporate governance rather
than simply being due to compensation consultant use. We begin analyzing this
possibility by investigating whether CEO pay levels in our sample are related to
differences in economic and governance factors, independent of the use of
compensation consultants. If weak governance leads to pay levels that are greater
than economic factors justify, we should first observe higher-than-predicted pay
when governance is weaker (for example, Lambert et al. 1993; Borokhovich et al.
1997; Conyon and Peck 1998; Daily et al. 1998; Core et al. 1999; Cyert et al. 2002;
Faleye 2007).
Similar to prior compensation studies, our initial tests in Table 3 estimate
ordinary least squares models with the natural logarithm of total annual CEO
compensation as the dependent variable. We first estimate the model including only
the economic variables and then add the governance variables to assess their
incremental explanatory power. Both of the models include industry fixed effects,
with t-statistics based on robust standard errors that are clustered at the one-digit
SIC industry level.
The majority of the explanatory power is provided by the economic variables.
When the models are estimated with the economic variables alone, the adjusted R2
is 71.0%.10 Coefficient signs on most of the economic determinants are consistent
with expectations. Pay tends to be higher in larger companies, in those with higher
stock returns in the prior year, and for CEOs who are older and have larger existing
10
Although these results indicate that a riskier compensation mix has a significant influence on pay
levels, the exclusion of Pay Mix has little effect on our other results. The economic variable that explains
the most of the variation in pay levels is firm size (the natural logarithm of market capitalization), which
has an adjusted R2 of 58.0% when included alone in an untabulated model.
123
Table 3 Economic and

(1) (2)
governance determinants of
annual compensation Intercept 9.968*** 9.593***
(37.93) (28.46)
Pay mix 1.519*** 1.455***
(10.88) (11.23)
Log (market cap) 0.393*** 0.339***
(31.87) (19)
Return on Assets -0.363* -0.294
(-1.85) (-1.52)
Change in ROA 0.104* 0.086
(1.85) (1.48)
Book-to-market -0.016*** -0.013***
(-3.63) (-2.88)
Prior return (-2) -0.087* -0.069
(-1.82) (-1.5)
Prior return (-1) 0.34*** 0.312***
(5.36) (5.02)
CEO tenure -0.025 -0.011
(-1.1) (-0.43)
CEO age 0.011*** 0.009***
(5.74) (4.46)
Log (portfolio IV) 0.05*** 0.055***
(2.62) (3.04)
New CEO -0.126*** -0.102**
(-2.83) (-2.11)
Founder CEO -0.167** -0.118*
(-2.32) (-1.88)
Number of directors 0.194
This table presents the estimated
coefficients and t-statistics of the (1.11)
regression where the natural % Outside directors 0.326***
logarithm of Total annual (3.65)
compensation is the dependent
variable. All of the remaining % Board old 0.226
variables are as defined in Tables 1, (1.47)
2. Industry fixed effects (based on % Board busy 0.379***
two-digit SIC unless there are
fewer than 25 observations, in (4.77)
which case based on one-digit SIC) Outside lead director -0.065**
are included but not reported in the (-2.46)
table. t-statistics are based on
robust standard errors that are % Outsider apptd. by CEO -0.028
clustered at the one-digit SIC (-0.72)
industry level. Model F-statistic is Staggered board -0.021
the F-statistic from an F-test of the
(-0.97)
statistical significance of the model.
F-statistic for DR-squared is the F- Dual class 0.134***
statistic for the change in R2 when (2.88)
the variables in addition to those in
Adj. R-squared (%) 71.0 72.3
Column (1) are added to the model.
Statistical significance at the 10, 5, Model F-statistic 431.69*** 273.30***
and 1% levels (two-sided) is F-statistic for DR-squared 11.00***
denoted by *, **, and ***,
Nobs 2,110 2,110
respectively
123
equity holdings. Pay tends to be lower when Book-to-Market is lower and the CEO
is either new to the position or a company founder. Contrary to our predictions, we
find that total pay is decreasing in Return on Assets in this model.11
When the governance variables are added, the models adjusted R2 increases to
72.3% (1.3% greater than the model without governance variables). An F-test for
the change in R2 from the addition of the governance variables is highly significant
(p \ 0.001), indicating that these variables as a group add statistically significant
(though modest economic) explanatory power. Four of the eight governance
variables are statistically significant (p \ 0.05, two-tailed), and all of the significant
variables have the predicted signs. Consistent with the claims of compensation
critics, total pay levels tend to be higher when board members are busier, the lead
director is an insider, and the firm has dual class voting shares. The governance
results in Table 3 support prior studies findings that CEO pay levels are higher than
predicted by economic characteristics when corporate governance is weaker.
4.2 Matched pair tests of pay levels and the use of compensation consultants
We next examine whether the higher total pay levels for consulting clients seen in
Tables 1, 2 (as well as in prior studies by Murphy and Sandino 2008; Conyon et al.
2009; and Cadman et al. 2010) are driven by firms with weaker corporate
governance rather than by the provision of consulting services. If firms using
consultants also have weaker governance, then the omission of governance
characteristics from the model leads to potential correlated omitted variable
problems and misinterpretation of the results.
In these tests, we employ a propensity score matched pair research design
(Rosenbaum and Rubin 1983), which requires a model for the conditional
probability of using a compensation consultant given observable features of the
companys contracting environment. We assume that the choice to use a consultant
is based on the economic and governance variables (or covariates) discussed
above, and we estimate a series of multivariate logistic models where the dependent
variable in each model equals one if a compensation consultant is used and zero
otherwise.
After estimating the conditional probability that a company uses a given
consultant, we match a firm that uses a consultant with a firm having a similar
probability of using a consultant but, in fact, does not. We employ a nonbipartite
matching algorithm suggested by Derigs (1988), which is an optimal algorithm in
the sense that it considers the potential distances between other matched pairs when
forming a particular matched pair. If pay levels in the matched pairs remain
significantly higher after matching on the economic covariates alone, but the
differences disappear after matching on both the economic and governance
covariates, the higher pay levels in the consultant users can be attributed to
governance differences rather than to the use of a consultant. For example, consider
11
In unreported analyses, we also include an indicator for whether Return on Assets is negative to allow
for a different level of compensation for loss firms. This indicator variable is negative but not statistically
significant, and the statistical significance of the other variables in the model is unchanged.
123
two pairs of matched firms. The matched firms in the first pair (one a consultant user
and the other a non-user) have similar economic characteristics, similar strong
governance characteristics, and similar pay levels. The matched firms in the second
pair (one a consultant user and the other a non-user) also have similar economic
characteristics, similar weak governance characteristics, and similar pay levels. If
this were the case, it would be impossible to conclude that consultant use is driving
pay differentials.
Propensity score matching has several advantages for these tests. First, the use or
non-use of a compensation consultant provides natural dichotomous treatment
(consultant) and control (no consultant) groups, the type of setting this statistical
method was designed to evaluate. Second, propensity score matching alleviates a
number of econometric problems found in typical regression models. In particular,
propensity score matching does not rely on a linear functional form linking the
outcome variable of interest (the level of CEO pay) with both the independent
variable of interest (compensation consultant) and the other predictor variables or
covariates (for example, firm size, industry, and governance practices). In
addition, propensity score matching provides some insight into the extent to which
the confounding effects of correlated omitted variables are likely to affect the
parameter estimates derived from a linear model.
The matched pair approach relaxes the strict functional form of the relation
between total pay levels and the compensation consultant treatment and other
covariates implicit in a linear regression model. With a matched pair research
design, the matched pairs are formed from observations that differ in the variable of
interest (that is, the use of a compensation consultant in this study) but are otherwise
similar along other relevant variables (that is, economic and governance charac-
teristics). Thus, any differences in CEO compensation levels can be attributed to
differences in the use of a compensation consultant rather than to differences in the
other covariates, regardless of the underlying structural form.
Our matched pair research design also explicitly acknowledges that compensa-
tion consultant use or non-use is not a result of random or exogenous assignment
and attempts to model the matching of firms consultant use on the basis of
observable variables (for example, economic and governance characteristics).12
After matched pairs have been formed on the basis of observable characteristics and
statistical tests for differences in compensation conducted, we can assess the
sensitivity of our significant results to unobservable, correlated omitted variables (or
hidden bias). Specifically, we can determine the magnitude of the correlated omitted
variable bias that is necessary to cause any statistically significant differences
between matched pairs to become insignificant. This computation enables us to
provide insight into whether the observed results are statistically robust.
12
Endogeneity can be addressed in OLS models using two-stage instrumental variable procedures.
However, this approach requires identifying appropriate instruments that are correlated with the
independent variable of interest but uncorrelated with the error term in the model, which can be difficult
in a study such as this. In addition, two-stage least squares continues to rely on linearity assumptions. As a
result, Larcker and Rusticus (2010) show that only under very restrictive conditions will two-stage least
squares reduce endogeneity problems in OLS.
123
4.2.1 Propensity scoring models of compensation consultant use
Table 4 presents results from our logistic propensity scoring models for consultant
use. Column 1 estimates the model using only the economic covariates. The model
is statistically significant with a pseudo-adjusted R2 of 15.3%. The probability of
using a compensation consultant is increasing in market capitalization and
decreasing in (1) the prior years stock return, (2) CEO tenure, (3) whether the
CEO is new to the position, and (4) the value of the CEOs equity portfolio. The
negative results for CEO tenure and equity portfolio are consistent with the
predictions of Cadman et al. (2010), although only CEO equity ownership is
significant in their consultant prediction model.
The addition of the governance variables in Column 2 increases the adjusted R2
to 21.8%. The significant coefficients on the governance variables are consistent
with claims that firms with weaker governance are more likely to employ
consultants to justify their pay levels.13 In particular, the probability of consultant
use increases if the firm has a larger board, a larger percentage of busy board
members, and a staggered board. All of these characteristics are assumed to be
indicators of weak governance. Companies with a larger percentage of old board
members are less likely to engage consultants, consistent with the univariate tests in
Tables 1, 2 that indicated that non-users tend to have older boards. Overall, the
evidence in Table 4 indicates that firms with weaker governance are more likely to
use compensation consultants, even after taking economic factors into account.
4.2.2 Covariate balance tests
The preceding propensity matching models are used to match firms that have similar
economic and governance characteristics but differ in their use of consultants.
Matching is done without replacement and using an optimal rather than a
greedy algorithm so that each matched pair is formed considering the effect of
the removal of those observations (since matching is without replacement) on
subsequent matches. The resulting sample size in these analyses is 263 matched
pairs (526 firms), since this is the number of firms in our sample that do not employ
compensation consultants and are therefore available for matching.
13
One of the necessary conditions to implement a propensity score research design is known as the
overlapping or common support assumption (Rosenbaum and Rubin 1983). This requirement rules out the
possibility that the propensity score model perfectly classifies observations into either the treatment or
control groups conditional on the observable covariates, X (that is, 0 \ Pr (Treatment = 1|X) \ 1). This
condition is necessary to ensure that for each observation, there is a potential match that has a similar
probability of receiving the treatment. In other words, it ensures that observations with the same
observables (that is, X) have a positive probability of both receiving the treatment and not receiving the
treatment. A related concern is a propensity score model with a low degree of explanatory power. If the
explanatory power of the model is too low, the propensity score research design essentially forms
matched pairs at random, which leaves a large scope for hidden bias to confound the results. In our case,
the propensity score models of the conditional probability of using a compensation consultant have
relatively high degrees of explanatory power (that is, 15.3% when only the economic variables are
included and 21.8% when the economic and individual governance variables are included), suggesting
that the matched pairs that we form in our next analysis are relatively similar on the basis of their
observable covariates.
123
Table 4 Determinants of
(1) (2)
consultant usage
Intercept 2.444*** -2.849**
(2.68) (-2.37)
Pay mix 1.246*** 0.999***
(3.73) (2.90)
Log (market cap) 0.551*** 0.257***
(7.63) (3.14)
Return on assets 0.340 0.571
(0.69) (1.17)
Change in ROA 0.511* 0.518*
(1.88) (1.95)
Book-to-market -0.013 -0.002
(-0.64) (-0.09)
Prior return (-2) -0.427*** -0.287**
(-3.69) (-2.33)
Prior return (-1) 0.250 0.074
(1.27) (0.37)
CEO tenure -0.329** -0.287**
(-2.44) (-2.03)
CEO age 0.000 0.001
(0.01) (0.15)
Log (portfolio IV) -0.234*** -0.131**
(-3.58) (-1.96)
New CEO -0.556* -0.462
(-1.82) (-1.48)
Founder CEO -0.054 0.124
(-0.26) (0.56)
Number of directors 1.865***
(5.47)
This table presents the estimated % Outside directors 2.133***
coefficients and z-statistics of a
logistic regression where (4.70)
Consultant usage is the % Board old -1.430***
dependent variable, which takes a (-2.90)
value of one if the firm uses a
% Board busy 0.733**
compensation consultant and zero
otherwise. All of the remaining (2.06)
variables are as defined in Outside lead director -0.197
Tables 1, 2. Industry fixed effects
(-1.17)
(based on two-digit SIC unless
there are fewer than 25 % Outsider apptd. by CEO -0.277
observations, in which case based (-1.12)
on one-digit SIC) are included but Staggered board 0.288**
not reported in the table. Z-
statistics are based on robust (1.97)
standard errors that are clustered Dual class -0.076
at the one-digit SIC industry (-0.31)
level. Statistical significance at
the 10, 5, and 1% levels (two- Pseudo adj. R-squared (%) 15.3 21.8
sided) is denoted by *, **, and Nobs 2,110 2,110
***, respectively
123
We evaluate the efficacy of our matching algorithm by examining the covariate

balance (that is, the similarity of the covariate distributions) between the matched
pairs within each consultant category. Covariate balance is achieved if the two
matched groups appear similar with respect to their observable contracting
environments (that is, the economic and/or governance covariates in the propensity
score equation). Lack of balance across certain covariates highlights an identifi-
cation problem that complicates separation of the treatment effect (that is,
compensation consultant use) and the effect of the unbalanced covariate (for
example, firm size or board structure).14
To assess covariate balance between the treatment and control groups, we
conduct tests of differences in means using parametric t-tests and differences in
medians using nonparametric KolmogorovSmirnov (KS) tests. The results are
reported in Table 5. Table 5 presents comparisons when only the economic
variables are used in the propensity score model. With the exception of median
(though not mean) differences in Return on Assets, none of differences in economic
characteristics are statistically significant in the treatment (consultant) and control
(no consultant) groups (p \ 0.10, two-tailed). Thus, the algorithm effectively
matches on these factors. However, the treatment and control groups continue to
exhibit significant differences in governance characteristics after matching on the
economic characteristics. In particular, the treatment group has more board
members and larger percentages of outsiders on their board and busy board
members, while the control group has a larger percentage of old board members. In
contrast, when the firms are matched on both economic and governance
characteristics (Table 6), they are not significantly different on any of the
characteristics, with the exception of median (but not mean) Pay Mix and CEO
Age. Again, this evidence suggests that the matching algorithm was effective in
identifying firms that are similar along the variables included in the propensity
matching model (though not on variables that are not included) but are in different
compensation consultant groups.
4.2.3 Matched pair pay level results
Table 7 presents the matched pair pay level results. We conduct parametric and
nonparametric tests of pay level differentials using t-tests and Wilcoxon signed-rank
tests. The results indicate that companies using compensation consultants continue
to exhibit statistically higher CEO pay (p \ 0.01, two-tail) than do their matched
counterparts with similar observable economic (but not governance) dimensions.
The mean ($529,618) and median ($300,425) differences are consistent with prior
14
To illustrate this point in the current context, suppose consulting firms consult only to relatively large
companies. Further, suppose that it is not possible to form matched pairs of firms that use consultants with
non-users of a similar size. In that case, there would be a lack of balance across the matched pairs with
respect to firm size. Consequently, any difference in the level of total compensation across the matched
pairs cannot be unambiguously attributed to using a compensation consultant, because the difference
could also be attributable to differences in firm size. Examining the covariate balance across the matched
pairs is therefore crucial for highlighting any identification problems that might exist.
123
Table 5 Matched pair analysis: economic matched pair covariate balance

Mean Mean Median Median t test KS bootstrap
treatment control treatment control difference difference
p value p value
Pay mix 0.634 0.658 0.623 0.662 0.273 0.128

Log (market capitalization) 6.243 6.150 6.225 5.991 0.480 0.291
Return on assets -0.003 -0.001 0.026 0.034 0.878 0.017
Change in ROA -0.013 -0.024 0.000 0.001 0.707 0.901
Book-to-market 0.291 0.341 0.400 0.380 0.778 0.495
Prior return (-2) 0.177 0.201 0.045 0.080 0.689 0.695
Prior return (-1) 0.145 0.159 0.106 0.087 0.704 0.965
CEO tenure 1.995 2.017 2.054 2.079 0.762 0.390
CEO age 55.103 54.795 55.000 54.000 0.679 0.214
Log (portfolio IV) 16.926 16.736 16.811 16.793 0.234 0.419
New CEO 0.106 0.103 0.000 0.000 0.887 0.943
Founder CEO 0.183 0.179 0.000 0.000 0.910 0.960
Number of directors 2.184 2.138 2.197 2.079 0.028 0.039
% Outside directors 0.671 0.626 0.700 0.625 0.001 0.011
% Board old 0.127 0.160 0.111 0.125 0.020 0.022
% Board busy 0.310 0.265 0.286 0.222 0.019 0.021
Outside lead director 0.692 0.753 1.000 1.000 0.120 0.129
% Outsider apptd. by CEO 0.715 0.726 0.800 1.000 0.713 0.036
Staggered board 0.471 0.414 0.000 0.000 0.189 0.189
Dual class 0.114 0.103 0.000 0.000 0.675 0.705
This panel presents the mean and median values of the variables across the treatment and control groups
where the treatment is whether a compensation consultant was used and firms are matched according to
the economic variables Pay mix, Log (market capitalization), Return on assets, Change in ROA, Book-to-
market, Prior return (-2), Prior return (-1), CEO tenure, CEO age, Log (portfolio IV), New CEO, and
Founder CEO. The last two columns present the p values of a paired t test and KolmogorovSmirnov test
across the treatment and control samples. All of the variables are defined in Tables 1, 2
studies findings that consulting clients pay their CEOs more than economic
characteristics predict.
As discussed earlier, one explanation for the statistically significant differences in
pay between consultant users and non-users is that corporate governance differences
are correlated omitted variables that are responsible for the significant consultant
results. Propensity score matching mitigates overt bias by balancing the relevant
covariates across the two categories of interest (in this case, firms that use
consultants and their matched counterparts that do not). However, the results are
susceptible to hidden bias as a result of correlated omitted variables that are not
balanced across the two categories (as seen for some of the governance variables in
the covariate balance tests in Table 5). Rosenbaum (2002, 2007) develops a
bounding approach for assessing the sensitivity of the matched pair results to hidden
123
Table 6 Economic and governance matched pair covariate balance

Mean Mean Median Median t test KS bootstrap
treatment control treatment control difference difference
p value p value
Pay mix 0.654 0.658 0.650 0.662 0.856 0.091

Log (market capitalization) 6.168 6.150 5.993 5.991 0.888 0.631
Return on assets -0.009 -0.001 0.030 0.034 0.623 0.631
Change in ROA -0.004 -0.024 0.001 0.001 0.488 0.409
Book-to-market 0.438 0.341 0.390 0.380 0.341 0.791
Prior return (-2) 0.173 0.201 0.042 0.080 0.631 0.717
Prior return (-1) 0.156 0.159 0.114 0.087 0.920 0.373
CEO tenure 1.970 2.017 2.054 2.079 0.522 0.320
CEO Age 54.544 54.795 54.000 54.000 0.729 0.077
Log (portfolio IV) 16.714 16.736 16.659 16.793 0.895 0.836
New CEO 0.118 0.103 0.000 0.000 0.578 0.604
Founder CEO 0.179 0.179 0.000 0.000 1.000 1.000
Number of directors 2.134 2.138 2.079 2.079 0.845 0.428
% Outside directors 0.622 0.626 0.625 0.625 0.767 0.811
% Board old 0.154 0.160 0.143 0.125 0.705 0.699
% Board busy 0.269 0.265 0.286 0.222 0.824 0.455
Outside lead director 0.757 0.753 1.000 1.000 0.919 0.954
% Outsider apptd. by CEO 0.711 0.726 0.875 1.000 0.619 0.509
Staggered board 0.395 0.414 0.000 0.000 0.658 0.694
Dual class 0.118 0.103 0.000 0.000 0.578 0.625
This panel presents the mean and median values of the variables across the treatment and control groups
where the treatment is whether a compensation consultant was used and firms are matched according to
the economic variables Pay mix, Log (market capitalization), Return on assets, Change in ROA, Book-to-
market, Prior return (-2), Prior return (-1), CEO tenure, CEO age, Log (portfolio IV), New CEO, and
Founder CEO and the governance variables Number of directors, % Outside directors, % Board old,
% Board busy, Outside lead directors, % Outsider apptd. by CEO, Staggered board, and Dual class. The
last two columns present the p values of a paired t test and KolmogorovSmirnov test across the treatment
and control samples. All of the variables are defined in Tables 1, 2
bias. In our context, hidden bias exists if two companies (denoted i and j) have the
same observed economic covariates but different probabilities (denoted p) of being
assigned to a consultant category (user or non-user). The odds that each company is
assigned to the relevant consultant category are denoted pi/(1-pi) and pj/(1-pj),
respectively. If the odds ratio, denoted by U, does not equal one, then the two
companies have an unequal probability of being assigned to a consultant category
and hidden bias exists. Rosenbaum (2002) shows that relaxing the assumption that
U = 1 allows computation of the amount of hidden bias needed to alter the
significant inferences. Smaller values indicate statistically significant results that are
more sensitive to hidden bias.
When we assess the sensitivity of our significant results when firms are matched
only on economic covariates, the significant (negative) difference in median pay
between the companies that do not use consultants and their matched counterparts
123
Table 7 Matched pair compensation differences

Matching variables Mean Median Wilcoxon p value t-statistic p value
compensation compensation statistic
difference difference
Economic $529,618 $300,425 3.179 0.001 1.719 0.087

Economic and governance $51,185 $74,539 1.318 0.187 1.087 0.279
This panel presents the results of the comparison of the level of Total Annual Compensation between the
firms that use a compensation consultant and do not use a compensation consultant. In the first row, firms
are matched according to the economic variables Pay mix, Log (market capitalization), Return on assets,
Change in ROA, Book-to-market, Prior return (-2), Prior return (-1), CEO Tenure, CEO age, Log
(portfolio IV), New CEO, and Founder CEO. In the second row, firms are matched according to the
economic variables and the governance variables Number of directors, % Outside directors, % Board old,
% Board busy, Outside lead directors, % Outsider apptd. by CEO, Staggered board, and Dual class. The
first two columns present the mean and median differences in the level of total annual compensation
between the firms that use a compensation consultant and their matched counterparts. The third and fourth
columns present a Wilcoxon statistic of the rank-sum difference in the median compensation between the
firms that use a compensation consultant and their matched counterparts and the corresponding p value
(two-sided). The fifth and sixth columns present a t-statistic for a test of the difference in the mean
compensation between the firms that use a compensation consultant and their matched counterparts and
the associated p value (two-sided)
would become insignificant if U = 1.24. The U of 1.24 means that a correlated

omitted variable (or variables) would only have to shift the assumed equal (50%/
50%) probability of being assigned to the no consultant category to a 54.4%/
44.6% (= 1.24) probability for the significant result to become insignificant at the
10% level. Thus, omitting a relevant variable that is only mildly correlated with
both being in the no consultant group and pay levels could produce the significant
results. The small magnitude of U in these analyses indicates that the results using
only economic covariates are sensitive to hidden bias due to correlated omitted
variables.
Given this limitation, we extend our matched pair pay level analysis to include
both economic and governance covariates. When matched on both sets of
covariates (Table 7), the pay level differences in the matched pairs are no longer
statistically significant (p [ 0.10, two-tailed). The lack of a significant difference
after matching on governance implies that these governance characteristics are
important correlated omitted variables in tests that include economic character-
istics alone. More importantly, the results are consistent with the attribution of pay
level differences in consultant users and non-users to governance differences
rather than with anything inherent in the use or non-use of compensation
consultants. The strong governance effect is consistent with prior studies that find
governance factors important in explaining executive compensation levels (for
example, Conyon and Peck 1998; Daily et al. 1998; Core et al. 1999). The results
are also consistent with the consulting clients with weak governance using
consultants advice to facilitate or justify pay packages in excess of what
economic characteristics alone would predict, while clients with stronger
governance use consultants advice to design efficient compensation plans
consistent with their economic characteristics.
123
4.3 Comparison with OLS results
As discussed earlier, our propensity score matched pair research design has
advantages in our research setting relative to traditional linear regression approaches
used in related studies. These advantages include relaxing the strict linear functional
form linking pay levels to consultant use and the other covariates and minimizing
correlated omitted variables problems that are likely to affect the parameter
estimates derived from a linear model. However, matching without replacement
limits our sample size in the propensity matching tests to 263 matched pairs (526
firms), which represents the number of firms in our sample that do not use
compensation consultants and are available for matching. Consequently, our
inability to detect any consultant effects on pay levels after matching on governance
characteristics may be due to the smaller sample size or sample composition.
To provide some evidence on whether the differences between our results and
prior studies are due to differences in research methods or to the smaller sample
used in the matched pairs tests, we estimate linear OLS models of pay levels on the
economic and governance variables and a compensation consultant indicator for
both the full sample and matched pair subsample. If our results are simply due to the
smaller matched pair sample, the consultant indicator should be significant in the
full sample and insignificant in the smaller matched pair subsample. We report the
results in Table 8. Consistent with prior studies, we find that when the consultant
indicator is included in the model with the economic variables alone, the coefficient
on the indicator is positive and highly significant (p \ 0.01, two-tailed) using either
sample. The coefficient on the consultant indicator remains positive and significant
in both samples when the governance variables are added, indicating that the
observed consultant effect does not disappear in the smaller sample in linear
regression tests. This evidence suggests that the insignificant consultant effects in
our propensity matched pair analyses are due to this methods econometric
advantages rather than to the smaller matched sample used in these tests.
4.4 Specialized vs. nonspecialized consultants
Although we assume that all compensation consultants have similar incentives to

facilitate (or not facilitate) the extraction of excess pay by CEOs of firms with
weak governance, compensation critics contend that the incentives to facilitate
higher pay levels are greater in nonspecialist consultants who also provide advisory
services other than compensation advice, such as actuarial services or benefits
administration. In many cases, these other services are more lucrative than the
compensation consulting engagement (Crystal 1991; U.S. House of Representatives
2007). Even if a nonspecialized consulting firm that offers a broad range of services
does not currently provide any additional services to the client, it may not want to
jeopardize the possibility of obtaining add-on work in the future (Bebchuk and
Fried 2004; U.S. House of Representatives 2007). Claims that broad-based service
offerings lead to conflicts of interest between consultants and clients suggest that
excess CEO pay should be higher in companies using nonspecialized, potentially
123
Table 8 OLS models of the determinants of annual compensation for the full sample and the matched
pair subsample
(1) (2) (3) (4)
Intercept 9.784*** 10.838*** 9.53*** 10.687***

(38.03) (36.65) (28.05) (28.05)
Pay mix 1.487*** 1.497*** 1.43*** 1.469***
(9.7) (8.32) (10.38) (7.67)
Log (market cap) 0.384*** 0.359*** 0.336*** 0.327***
(32.01) (18.53) (18.89) (11)
Return on Assets -0.376* -0.345*** -0.309 -0.261**
(-1.85) (-2.91) (-1.53) (-2.13)
Change in ROA 0.088 0.049 0.072 0.039
(1.3) (1.63) (1.07) (1.26)
Book-to-market -0.016*** -0.045 -0.013*** -0.046
(-3.46) (-1.02) (-2.83) (-1.1)
Prior return (-2) -0.075 -0.127*** -0.062 -0.119***
(-1.54) (-3.71) (-1.31) (-3.29)
Prior return (-1) 0.335*** 0.227*** 0.311*** 0.204**
(5.12) (2.9) (4.85) (2.58)
CEO tenure -0.019 -0.075* -0.006 -0.08*
(-0.81) (-1.68) (-0.25) (-1.67)
CEO age 0.011*** 0.008*** 0.009*** 0.006
(6.24) (2.75) (4.85) (1.55)
Log (portfolio IV) 0.055*** 0.018 0.058*** 0.013
(2.76) (0.85) (3.11) (0.56)
New CEO -0.116*** -0.165 -0.097** -0.151
(-2.73) (-1.46) (-2.05) (-1.27)
Founder CEO -0.164** -0(-0.03) (-1.93) 0.031
(-2.32) .003 -0.119* (0.39)
Consultant Used 0.197*** 0.225*** 0.165*** 0.215***
(2.95) (3.31) (3.06) (3.82)
Number of Directors 0.161 0.111
(0.92) (0.76)
% Outside Directors 0.29*** 0.283**
(3.44) (2.27)
% Board Old 0.254* 0.240
(1.7) (1.06)
% Board Busy 0.369*** 0.32**
(4.54) (2.13)
Outside Lead Director -0.063** -0.015
(-2.43) (-0.27)
% Outsider Apptd. by CEO -0.027 0.100
(-0.67) (1.11)
123
Table 8 continued
(1) (2) (3) (4)
Staggered Board -0.027 -0.121**

(-1.25) (-1.96)
Dual Class 0.136*** 0.113
(2.86) (1.17)
Adj. R-squared (%) 71.5 60.9 72.6 62.1
Model F-statistic 404.99*** 61.09*** 263.18*** 38.38***
F-statistic for DR-squared 11.80*** 3.96***
Nobs 2,110 526 2,110 526
This table presents the estimated coefficients and t-statistics of regressions where the natural logarithm of
Total annual compensation is the dependent variable using the full sample (Columns (1) and (3) and the
subsample of firms from the matched pair analysis (Columns (2) and (4)). All of the remaining variables
are defined in Tables 1, 2. Industry fixed effects (based on two-digit SIC unless there are fewer than 25
observations, in which case based on one-digit SIC) are included but not reported in the table. t-statistics
are based on robust standard errors that are clustered at the one-digit SIC industry level. Model F-statistic
is the F-statistic from an F-test of the statistical significance of the model. F-statistic for DR-squared is
the F-statistic for the change in R2 when the variables in addition to those in columns (1) and (2) are
added to the model. Statistical significance at the 10, 5, and 1% levels (two-sided) is denoted by *, **, and
***, respectively
conflicted consultants than in those using specialized, nonconflicted compen-

sation consultants.15
We examine this issue by grouping the consulting firms in our sample into
nonspecialized firms that offer a broad range of services (Towers Perrin, Mercer,
Hewitt, Watson Wyatt, Radford, and Hay) and specialized firms that limit their
offerings to compensation advice (Frederic Cook, Pearl Meyer, Compensia, and the
remaining smaller, primarily boutique firms). We conduct a propensity score matched
pair analysis on the subsample of firms that use compensation consultants. Companies
that do not use consultants are excluded. We treat specialized firms as the treatment
group and nonspecialized (potentially conflicted) firms as the control group.
In the (untabulated) propensity scoring model, we find that firms are more likely
to use specialized consultants when they have a lower market capitalization, lower
returns in the two prior years, and a CEO who is a founder. With respect to the
governance variables, the percentage of board members who are outsiders and
the percentage of busy board members have significant negative associations with
the probability of using specialized consultants, who are claimed to have fewer
conflicts of interest. The latter significant governance variable is consistent with
claims that firms with weaker governance choose nonspecialized consultants who
15
The separation into potentially conflicted and nonconflicted consultants is consistent with that
used in U.S. government investigations (for example, U.S. House of Representatives 2007). Academic
research to date provides mixed support for the prediction that consultants providing additional services
are associated with higher pay levels, with Conyon et al. (2009) and Cadman et al. (2010) finding no
support for these claims and Murphy and Sandino (2010) finding some support depending upon the type
of additional service provided. However, these studies provide relatively little evidence on the extent to
which governance influences these results.
123
may be more likely to facilitate excess pay to protect their other work. However, the
majority of the governance variables are insignificant, and the explanatory power in
these propensity scoring models is quite low (adjusted pseudo R2s range from 3.3%
in the model including only economic variables to 4.1% in the model including both
economic and governance variables). Thus, in contrast to the use or non-use of
compensation consultants, neither the economic nor governance covariates is a
strong predictor of the use of specialized versus non-specialized consultants (given
the choice to use a consultant). The subsequent propensity matching results should
therefore be interpreted accordingly.
To achieve adequate covariate balance, we trimmed 10% of the observations.
The resulting (untabulated) comparisons of mean and median pay level differences
between the matched pairs revealed no significant differences after controlling for
economic characteristics alone or for both economic and governance characteristics
(p \ 0.10, two-tailed). These results provide no support for claims that pay levels
are higher in potentially conflicted consulting firms that offer a broad variety of
services.16
5 Conclusion
This study contributes to the debate over the influence of corporate governance on
CEO pay levels and the role compensation consultants play in this relation.
Although a number of prior studies provide evidence that CEO pay levels are higher
in companies using compensation consultants, they provide little evidence regarding
why this relation exists. Using a larger sample of firms than was used in previous
studies, we continue to find that CEO pay is higher than predicted by economic
determinants in firms using consultants. However, we also find that companies with
weaker corporate governance are more likely to use compensation consultants. After
using propensity scoring methods to match firms on both economic and governance
characteristics, we find no significant pay differences in consultant users and non-
users. These results imply that the higher observed pay levels in firms using
compensation consultants is largely driven by governance differences, with
economically similar firms with comparable governance characteristics having
similar pay levels, regardless of whether they engage a compensation consultant.
Moreover, these results do not vary between specialized and nonspecialized
(potentially conflicted) consultants, providing no support for claims that consultants
who offer a broad range of services are more likely to facilitate excess pay levels
because of greater conflicts of interest.
Our results are subject to three primary limitations. First, we (and other studies
using U.S. proxy statement data) do not have information on the magnitude of other
16
Further analysis indicates that governance characteristics help explain pay levels even within clients of
individual consultants. This evidence indicates that it is not the use of specific consultants but governance
differences that explain the observed relation between consultant use and excess pay levels. Additional
analysis of the association between individual consultants and CEO pay levels is provided in an earlier
version of this study, titled Economic Characteristics, Corporate Governance, and the Influence of
Compensation Consultants on Executive Pay Levels, available at http://ssrn.com/abstract=1145548.
123
noncompensation services consultants provide, nor do we have the potential to

obtain this information in the future, because U.S. companies are not required to
disclose it. This lack of information limits our ability to examine claims that
consultants with conflicts of interest contribute to rent extraction. Second, our data
analyses provide no way to determine whether or when consultants play an active
role in facilitating rent extraction by CEOs in firms with weak governance. Finally,
we do not have time series data on consultant usage and do not know whether
consultants were used before the new disclosure requirements or how changes in
compensation consultants influenced CEO pay levels. Future studies can extend our
analysis by examining evolving compensation consultant usage and pay levels in the
years following the new disclosure requirements.
Acknowledgments This paper has benefited greatly from many insightful discussions with Paul
Rosenbaum. We also thank Bo Lu for making available his code to perform the nonbipartite matching
algorithm used in this study, and two anonymous reviewers and Katherine Schipper (editor) for their
comments. Funding from the Dorinda and Mark Winkelman Distinguished Scholar Award (Armstrong)
and Ernst & Young (Ittner) is gratefully acknowledged.
References
Adams, R., & Ferreira, D. (2007). A theory of friendly boards. Journal of Finance, 62, 217250.
Albuquerque, A. (2009). Peer firms in relative performance evaluation. Journal of Accounting and
Economics, 48, 6989.
Allen, M. P. (1981). Power and privilege in the large corporation: Corporate control and managerial
compensation. American Journal of Sociology, 86, 11121123.
Almazan, A., & Suarez, J. (2003). Entrenchment and severance pay in optimal governance structures.
Journal of Finance, 58, 519547.
Anderson, S., Pizzigati, S., Collins, C., Cavanagh, J., & Cray, C. (2007). Selfish interest: How much
business roundtable CEOs stand to lose from real reform of runaway executive pay. Washington:
Institute for Policy Studies.
Armstrong, C., Jagolinzer, A., & Larcker, D. (2010). Chief executive officer equity incentives and
accounting irregularities. Journal of Accounting Research, 48, 225271.
Bebchuk, L., & Fried, J. (2003). Executive compensation as an agency problem. Journal of Economic
Perspectives, 17, 7192.
Bebchuk, L., & Fried, J. (2004). Pay Without Performance: The Unfulfilled Promise of Executive
Compensation. Cambridge: Harvard University Press.
Bizjak, J., Lemmon, M., & Naveen, L. (2008). Does the use of peer groups contribute to higher pay and
less efficient compensation? Journal of Financial Economics, 90, 152168.
Borokhovich, K. A., Brunarski, K. R., & Parrino, R. (1997). CEO contracting and antitakeover
amendments. Journal of Finance, 52, 14951517.
Buffett, W. (2007). Letter to shareholders. Omaha: Berkshire Hathaway.
Cadman, B. D., Carter, M. E., & Hillegeist, S. A. (2010). The incentives of compensation consultants and
CEO pay. Journal of Accounting and Economics, 49, 263280.
Campos, R. C. (2007). Speech by SEC commissioner: Remarks before the 2007 summit on executive
compensation. New York: Securities and Exchange Commission.
Coles, J., Daniel, N., & Naveen, L. (2008). Boards: Does one size fit all? Journal of Financial Economics,
87, 329356.
Conyon, M., & Peck, S. (1998). Board control, remuneration committees, and top management
compensation. Academy of Management Journal, 41, 146157.
Conyon, M., Peck, S., & Sadler, G. (2009). Compensation consultants and executive pay: Evidence from
the United States and United Kingdom. Academy of Management Perspectives, 23, 4355.
Core, J., & Guay, W. (1999). The use of equity grants to manage optimal equity incentive levels. Journal
of Accounting and Economics, 28, 151184.
123
Core, J., Holthausen, R., & Larcker, D. (1999). Corporate governance, chief executive officer
compensation, and firm performance. Journal of Financial Economics, 51, 371406.
Corporate Library (2007). The effect of compensation consultants: A study of market share and
compensation policy advice.
Crystal, G. (1991). In search of excess: The overcompensation of American executives. New York: W.W.
Norton.
Cyert, R., Kang, S., & Kumar, P. (2002). Corporate governance, takeovers, and top-management
compensation: Theory and evidence. Management Science, 48, 453469.
Daily, C., Johnson, J., Ellstrand, A., & Dalton, D. (1998). Compensation committee composition as a
determinant of CEO compensation. Academy of Management Journal, 41, 209220.
Daines, R., & Klausner, M. (2001). Do IPO charters maximize firm value? Antitakeover protection in
IPOs. Journal of Law Economics and Organization, 17, 83120.
Derigs, U. (1988). Solving non-bipartite matching problems via shortest path techniques. Annals of
Operations Research, 13, 225261.
Faleye, O. (2007). Classified boards, firm value, and managerial entrenchment. Journal of Financial
Economics, 83, 501529.
Faulkender, M., & Yang, J. (2010). Inside the black box: The role and composition of compensation peer
groups. Journal of Financial Economics, 96, 257270.
Fich, E. M., & Shivdasani, A. (2006). Are busy boards effective monitors? Journal of Finance, 61,
689724.
Frank, B. (2007). Conversations: Rep. Barney Frank: Mandating a say on pay. The Corporate Board,
July/August 2007.
Goh, L., & Gupta, A. (2010). Executive compensation, compensation consultants, and shopping for
opinion: Evidence from the UK. Journal of Accounting, Auditing and Finance, forthcoming.
Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal
of Economics, 118, 107155.
Journal of Corporation Law (2005). Symposium on Bebchuk and Frieds pay without performance,
Summer, 749.
Lambert, R., & Larcker, D. (1987). An analysis of the use of accounting and market measures of
performance in executive compensation contracts. Journal of Accounting Research, 25, 85125.
Lambert, R., Larcker, D., & Weigelt, K. (1993). The structure of organizational incentives.
Administrative Science Quarterly, 38, 438461.
Larcker, D., & Rusticus, T. (2010). On the use of instrumental variables in accounting research. Journal
of Accounting and Economics, 49, 186205.
Laux, V. (2008). Board independence and CEO turnover. Journal of Accounting Research, 46, 137171.
Morgenson, G. (2006a). Advice on bosss pay may not be so independent. The New York Times, Apr 10,
2006.
Morgenson, G. (2006b). Peer pressure: Inflating executive pay. The New York Times, Nov 26, 2006.
Morgenson, G. (2008). Royal pay at Delphi, reined in by a judge. The New York Times, Jan 27, 2008.
Murphy, K. J. (1999). Executive compensation. In O. Ashenfelter & D. Card (Eds.), Handbook of labor
economics (pp. 24852563).
Murphy, K. J., & Sandino, T. (2008). Executive pay and independent compensation consultants.
Working Paper. University of Southern California.
Murphy, K. J., & Sandino, T. (2010). Executive pay and independent compensation consultants.
Journal of Accounting and Economics, 49, 247262.
Piore, A. (2007). The money men. Portfolio.com. http://www.portfolio.com/careers/features/2007/05/
17/The-Money-Men. Accessed May 17, 2011.
Prendergast, C. (1999). The provision of incentives in firms. Journal of Economic Literature, 37, 763.
Rajgopal, S., Taylor, D., & Venkatachalam, M. (2011). Frictions in the CEO labor market: The role of
talent agents in CEO compensation. Contemporary Accounting Research, Forthcoming.
Rosenbaum, P. R. (2002). Observational studies (2nd ed.). Berlin: Springer Series in Statistics.
Rosenbaum, P. R. (2007). Sensitivity analysis for m-estimates, tests, and confidence intervals in matched
observational studies. Biometrics, 63, 456464.
Rosenbaum, P. R., & Rubin, D. (1983). The central role of the propensity score in observational studies
for causal effects. Biometrika, 70, 4155.
Smith, C., & Watts, R. (1992). The investment opportunity set and corporate financing, dividend, and
compensation policies. Journal of Financial Economics, 15, 229.
123
U.S. House of Representatives (2007). Executive pay: Conflicts of interest among compensation
consultants. Committee on Oversight and Government Reform.
Wade, J., Porac, J., & Pollock, T. (1997). Worth, words, and the justification of executive pay. Journal of
Organizational Behavior, 18, 641664.
Wang, C., Xie, F., & Masulis, R. (2010). Agency problems at dual-class companies. Journal of Finance,
forthcoming.
Yermack, D. (1996). Higher market valuation of companies with a small board of directors. Journal of
Financial Economics, 40, 185211.
123

Armstrong Et Al 2012

Caricato da

Informazioni sul documento

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Armstrong Et Al 2012

Caricato da

Copyright:

Formati disponibili

Rev Account Stud (2012) 17:322351

Corporate governance, compensation consultants,

Christopher S. Armstrong Christopher D. Ittner

Published online: 9 March 2012

Keywords Equity incentives Corporate governance Executive compensation

JEL Classification G30 G34 M12 M52 M55

C. S. Armstrong C. D. Ittner (&)

2.1 CEO pay, governance, and compensation consultants

including the executives ability to support the nomination and retention of

commissioner noted, It is extremely difficult to avoid using high comparables, and

2.2 Related research

3 Sample and variable measurement

3.1 Compensation consultant use

3.3 Economic determinants

Consistent with prior theoretical and empirical compensation research, we include

3.4 Governance measures

Prior studies linking corporate governance to compensation practices have typically

In addition to the preceding economic and governance factors, the compensation

3.6 Descriptive statistics

Consultant used No consultant used One-way Kruskal

Table 2 Correlation matrix

Table 2 reports correlations between our variables. Total annual compensation is

4.1 Economic and governance determinants of CEO pay levels

Table 3 Economic and

4.2.1 Propensity scoring models of compensation consultant use

4.2.2 Covariate balance tests

We evaluate the efficacy of our matching algorithm by examining the covariate

4.2.3 Matched pair pay level results

Table 5 Matched pair analysis: economic matched pair covariate balance

Pay mix 0.634 0.658 0.623 0.662 0.273 0.128

Table 6 Economic and governance matched pair covariate balance

Pay mix 0.654 0.658 0.650 0.662 0.856 0.091

Table 7 Matched pair compensation differences

Economic $529,618 $300,425 3.179 0.001 1.719 0.087

would become insignificant if U = 1.24. The U of 1.24 means that a correlated

4.3 Comparison with OLS results

4.4 Specialized vs. nonspecialized consultants

Although we assume that all compensation consultants have similar incentives to

Intercept 9.784*** 10.838*** 9.53*** 10.687***

(1) (2) (3) (4)

Staggered Board -0.027 -0.121**

conflicted consultants than in those using specialized, nonconflicted compen-

noncompensation services consultants provide, nor do we have the potential to

Potrebbero piacerti anche

Intercept 9.784* 10.838* 9.53* 10.687*