Accounting for explanations of CEO compensation: substance and symbolism

Administrative Science Quarterly,  June, 1995  by Edward J. Zajac,  James D. Westphal

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While current debates about CEO compensation have generally been dominated by economic and political perspectives on CEO/board relations, we argue in this paper that CEO compensation may be driven by symbolic as well as substantive considerations. We develop an interdisciplinary theoretical framework to (1) explain why alternative explanations rooted in agency and human resource logics may be used to reduce ambiguity surrounding the adoption of new incentive plans for CEOs and (2) identify the possible structural (e.g., institutional, demographic, and economic), and interest-based (e.g., political) factors influencing the use of such explanations. We generate and test hypotheses predicting the alternative explanations for new long-term incentive plans using data taken from proxy statements over a 15-year period. The findings support the notion that explanations for CEO compensation reflect both substance and symbolism.(*)

In recent years, chief executive officer (CEO) compensation has come under increasingly close and harsh scrutiny, both in the academic literature and the popular press (Jensen and Murphy, 1990; New York Times, 1992). The popular business press has tended to portray executive compensation as excessive (Crystal, 1991; Time, 1993) or out of control (Business Week, 1992) and has generally supported legislative initiatives aimed at reform (Time, 1993). Such attempts include the recent U.S. political decision to question the corporate tax deductibility of executive salaries above $1 million and the efforts of some firms to limit CEO compensation to a multiplier of entry-level-employee compensation Opponents of these efforts, often economists, decry the visible hand of regulation in the presumably economic decision about the level of CEO compensation (Jarrell, 1993) and, in the case of multiplier limits, suggest that there is efficiency in structuring compensation in large organizations as "tournaments" in which compensation at higher levels is much greater than that at lower levels (Lazear and Rosen, 1981)

This debate has expanded to include long-term incentive compensation, which has become an increasingly significant component of executive pay (Jarrell, 1993). Once viewed by most observers as connoting managerial value and devotion to shareholders' interests (e.g., Crystal, 1984), long-term incentive plans have recently been negatively portrayed as insidious devices that serve only to enrich top management at the expense of shareholders (Crystal, 1991; Business Week, 1992). Such trenchant criticism has helped create widespread skepticism among corporate stakeholders about the motivation for long-term incentives while bolstering legislative efforts to curtail their use (Time, 1993). Jensen and Murphy (1990: 254-255) have suggested that firms are deterred from making full use of long-term incentive plans for CEOs because of the threat of "media criticism and ridicule," which they view as a regrettable form of "implicit regulation." Thus debate surrounding CEO compensation reflects the tension between the economic efficiency of an ideally constructed compensation contract (as agency theorists seek to devise) versus the alleged political reality of entrenched, overcompensated CEOs and weak boards. In this study, we argue for the need to consider a third perspective: the possibility that CEO compensation debates are also driven by symbolic considerations.

From a symbolic management perspective, the concern about whether CEOs in large U.S. corporations are overpaid or "worth every nickel they get" (Murphy, 1986: 125) is less important than how firms communicate the rationales underlying their CEO compensation decisions. According to this perspective, existing CEO compensation debates typically revolve around the subjective assessment of whether CEO compensation decisions can be considered "justifiable" in the eyes of organizational stakeholders and appeal less to economic logic than to the subjective social perception that some fixed amount (e.g., $1 million) or multiplier (e.g., 12 times that of an entry-level person) is the limit of what constitutes justifiable compensation for a CEO. Compensation beyond that amount could be subject to different interpretations by different stakeholders, some negative and some positive. Very high CEO compensation could be viewed either as an indication of corruption in the upper echelons of management or as a deserved reward for an extraordinary CEO. Thus, given ambiguity about the purpose or implications of high CEO rewards, new incentive arrangements that increase the upper bound of CEO compensation levels represent a justification problem (or opportunity) for corporate leaders. Accordingly, there may be value in studying not only how and how much firms decide to compensate their CEOs but also how firms explain their compensation decisions to shareholders and other interested constituents, including stock analysts, governmental regulators, governance activists, and prospective shareholders.