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Are company founders underpaid?

2012; Taylor & Francis; Volume: 45; Issue: 18 Linguagem: Inglês

10.1080/00036846.2012.669463

1466-4283

Konstantinos Tzioumis,

Family Business Performance and Succession

Abstract This article examines the relation between founder status and CEO compensation in publicly listed US firms. The results suggest that CEO/founders receive lower cash pay and total compensation compared to professional managers. In contrast, CEOs who are relatives of the founders receive similar cash pay and total compensation to that of professional managers. Different compensation levels also emerge in terms of stock option awards. The findings underline the importance of distinguishing among these three CEO types when examining the determinants of executive compensation. Keywords: foundersexecutive compensationstock optionsrepricingJEL Classification:: G30J33M52 Acknowledgements This research has been benefitted from the helpful comments of three anonymous referees, the editor (Mark Taylor), Stijn Claessens, Robert Cull, David De Meza, Asli Demirguc-Kunt, Rafael Gomez, Morley Gunderson, Luc Laeven and Gerasimos Lianos. A substantial part of this article was completed while the author was at the London School of Economics. The opinions expressed in this article are those of the author alone, and do not necessarily reflect the views of the Office of the Comptroller of the Currency or the Department of the Treasury. Notes 1 For instance, in Forbes' 2001 list for the 'best value' CEOs, all CEOs in the top 5 were founders or co-founders of their company [namely, W. Buffett (Berkshire Hathaway), K. Adams Jr (Adams Resources and Energy), E. Harari (SanDisk), D. Miller (Biomet), A.West Jr (SEI Investments)]. On the other hand, the cases of company founders L. Ellison (Oracle), S. McNealy (Sun Microsystems) and H. Silverman (Cendant) were repeatedly used in the press during the 1990s in order to illustrate allegedly exorbitant CEO compensation. 2 For instance, in NACCO Industries, Alfred M. Rankin Jr (CEO and grandson of the firm's founder) owns approximately 12% of the firm's equity, while the rest of the Rankin family collectively owns about 55% (Source: Hoovers Online, 2003). 3 Bhide (Citation2000) conducted a survey on entrepreneurship in the US and found that the majority of founders of successful firms had no prior experience in the industry they were entering. Moreover, he finds that most successful founders (as distinguished from small business entrepreneurs in general) aspire to create a large, national, or multinational company and intend to do whatever is required to achieve that objective. Holmes and Schmitz (Citation1990) have captured these particular functions of founders in a formal theory of entrepreneurship. 4 Existing empirical evidence on repricing is mixed, thus allowing for speculation concerning managerial influence on the repricing process. Saly (Citation1994), utilizing data from the 1980's, finds strong evidence that justifies the use of repricing as a re-incentive mechanism after a stock-market crash. In particular, he finds that stock option contracts are renegotiated after a market-wide downturn in stock-prices, such as after the market crash of October 1987. However, Chance et al. (Citation2000) suggest that repricing for top executives is usually carried out by firms with greater agency problems such as relative smaller size and insider-dominated boards. They further suggest that in most cases, repricing can be avoided because after a 2-year period the options would have been in-the-money. Similarly, it has been found that the likelihood of repricing for top executives is higher in smaller, younger, high technology firms (Carter and Lynch, Citation2001; Chidambaran and Prabhala, Citation2003), and firms with conflict of interest on the board's compensation committee (Brenner et al., Citation2000). 5 Similar studies examining effects of CEO/founders on compensation have much smaller sample compared to the present study, which has 9867 observations. In particular, Rose and Shepard (Citation1997), Anderson and Bizjak (Citation2003) and Gomez-Mejia et al. (Citation2004) have 1493, 1376 and 253 observations, respectively. 6 In fact, in Brenner et al. (Citation2000) and Yermack (Citation1995), the total sample of executives who had their stock options repriced was less than 2%, just like in the sample utilized in this article. 7 These 31 observations are most probably associated with either a promotion award after internal succession (when an executive has her options repriced the year she is promoted to CEO) or as an incentive to the CEO to avert him/her from voluntarily exiting the firm (when a CEO has her options repriced but soon after decides to exit the firm). Both these types of repricing incidents are dropped because they are special cases, motivated by factors unrelated to the study of managerial entrenchment. 8 Execucomp's occasional erroneous reporting of repricing events was first mentioned by Brenner et al. (Citation2000). 9 The results from mean comparison tests between the final sample (131 repricing obs.) and the original sample (177 repricing obs.) indicate no differences in any independent or control variable, thus demonstrating that the missing variables in the 46 observations are randomly omitted. 10 The practice of interlocking CEO and compensation committee structures could influence compensation directly, due to a direct CEO presence in the compensation committee, or indirectly due to external compensation committee membership exchanges. The related indicator variable used in this study refers to any of the following two situations showing conflict of interest in the compensation committee that firms are obliged to disclose in their proxy's 'Compensation committee interlocks and insider participation' section: (a) The CEO serves on the board committee that makes decisions on executive compensation (i.e. compensation committee); (b) The CEO serves on the board and/or compensation committee of another company that has an executive officer serving on the board and/or the compensation committee of the indicated CEO's company. 11 As a result, the specifications for cash pay and total compensation do not contain industry effects because fixed-effects estimation drops time-invariant variables. Panel data random-effects estimation was not employed since the Hausman test rejects the random-effects assumption that disturbances and explanatory variables are independent. Also, another reason for performing panel data fixed-effects estimation is that the Breusch–Pagan's Lagrange multiplier test rejects the classic pooled Ordinary Least Square (OLS) regression model. 12 Previous research has dealt with the selection problem arising from the logarithmic transformation in various ways. Yermack (Citation1995) and Anderson and Bizjak (Citation2003) employ the Tobit method, while Core and Guay (1999, 2001) apply Heckman estimation with the inverse Mills ratio. However, both practices have attracted criticism. For instance, Tobit assumes a single decision behind stock option grants, and Heckman's sample selection perceives the missing outcomes as unobservable rather than the result of logarithmic transformation. Notably, the findings from two-part estimation are robust with alternative estimation methodologies such as the Tobit and Heckman estimations. Results are available from the author upon request. 13 This is important since the determinants of the decision to adopt CEO stock options are not necessarily the same with the determinants of the level of CEO stock-option compensation (Tzioumis, Citation2008). 14 Tobin's Q is calculated using the methodology outlined by Gompers et al. (Citation2003). 15 The effects are found by calculating (), where is the respective estimate. 16 Following Pastor and Veronesi (Citation2003), we calculate firm age using the date that each firm appears either in the Compustat dataset or the CRSP files as the date of origin. Also, the respective firm age for firms with a professional manager as the CEO is 29.6 years. 17 According to the human capital theory, this concavity corresponds to the decline in the fraction of earnings capacity invested in on-the-job training during the working life of an individual, which eventually reaches zero value at the end of the individual's career. Indeed, the inclusion of a square term for 'CEO Tenure' in the fixed-effects panel data estimations for 'Cash Pay' and 'Total Compensation' yields significant and negative coefficients, thus indicating declining returns from tenure as CEO in a firm. 18 Indeed, in the sample utilized in the logit estimation, the Pearson correlation between firm size and share volatility is –0.53.