New Research Sheds Light on Phenomenon that an Increase CEO Pay by 10%
It’s common knowledge that chief executive officers (CEOs) of companies are highly paid, but new research shows a certain phenomenon can bump that yearly salary up even higher—about 10% higher.
New research in the INFORMS journal Management Science finds CEO compensation climbs if they appoint a chief financial officer (CFO) after them. The increased compensation is mostly concentrated in the early years of the newly hired CFO’s tenure and in components of compensation that vary with hitting analyst-based earnings targets. The work suggests that some finance chiefs might be pressured to tweak earnings to boost the stock price, and as a result, CEO compensation.
CEOs most often have power over CFOs not only in title, but also in standing. This is arguably even more pronounced when they have a hand in hiring them. If you are a new CFO, you don’t want to disappoint your boss so you are more likely to follow their lead and succumb to pressures. This is a common explanation for the study results. However, over time, CFOs themselves gain influence within the company and may not feel as pressured to push the boundaries as much as they did in the beginning of their tenure, hence, why the increased compensation is mostly concentrated in the first few years of the CFO’s tenure.
To give you some background, CEO compensation has grown by 940% since 1978, compared to a mere 12% increase for employees during that same time frame. This expands our point that while it’s no secret that company CEOs are doing well, a CFO hired by the CEO can impact the CEO’s salary in a very significant way.
Along with my co-authors, Bill Mayew of Duke University, Shane Dikolli of the University of Virginia and Mani Sethuraman of Cornell University, we looked at 20 years of data from S&P 1500 firms to reach our conclusions.
The paper, “CFO co-option and CEO compensation,” sheds light on how the relationship between these two top decision-makers in a firm can shape the external financial reporting and subsequent payout to the firm’s CEO. The findings also help put into context how the intersection of financial reporting and performance evaluation processes impact corporate outcomes in general and executive compensation more specifically.
This may not be an immediate concern to corporate executives who, based on average tenure, may not be around long enough to deal with the negative implications of their decisions. It is important that boards and hiring committees are aware that this dynamic between the CEO and CFO exists, and keep it in mind during the hiring process.
Up until now this phenomenon has been difficult to document, but this work provides evidence to substantiate claims that have long been thought to be true—there is a link between the power structure at the top levels of a corporation and financial reporting decisions.
Based on this research, CEOs have an obvious influence on employees who could potentially increase their pay, but being aware of it is half the battle for boards and hiring committees. It’s important for CFOs to establish support within the company. If staff members have your back, you feel less pressure to always go along with the boss.
Commentary by John Heater. Here’s what you’ve missed?
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