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An Examination of the Effect of CEO Social Ties and CEO Reputation on Nonprofessional Investors’ Say-on-Pay Judgments

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Abstract

CEO compensation has received much attention from both academics and regulators. However, academics have given scant attention to understanding judgments about CEO compensation by third parties such as investors. Our study contributes to the ethics literature on CEO compensation by examining whether judgments about CEO compensation (e.g., say-on-pay) are influenced by two aspects of a company’s tone at the top—social ties between the CEO and members of the Executive Compensation Committee (ECC) and the CEO’s Reputation, particularly for financial reporting and disclosures. Although, stock exchanges such as NASDAQ require ECC members to be independent, CEOs still may have social connections to the ECC. In addition, CEOs develop a reputation for the quality of their company’s financial reporting and disclosures. We expect both CEO Social Ties and CEO Reputation to impact say-on-pay judgments, and that fairness perceptions about the CEO compensation will mediate the relationship. We conduct an experiment to test our hypotheses. In this study, we employ a two by two experimental design where we manipulate CEO Social Ties with members of the ECC (present/absent) and CEO Reputation for the quality of financial reporting disclosures (favorable/unfavorable). Participants were MBA students who provided a say-on-pay judgment (e.g., their agreement or disagreement with a resolution stating approval of the compensation paid to the Company’s CEO), and judgments about the fairness of the CEO’s compensation. Results indicate that CEO Social Ties affected participants’ say-on-pay judgments, which were fully mediated by their perceptions about fairness of the CEO’s compensation. Further, the CEO’s Reputation also affected participants’ say-on-pay judgments, which were fully mediated by their perceptions about fairness of the CEO’s compensation. Implications for research and public policy are presented.

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Notes

  1. Major exchanges have specific rules about who may serve on the ECC. For example, major exchanges generally require members of the ECC to be independent in an economic or agency sense such that ECC members may not be employed by the firm and may not have any direct economic ties to the CEO. However, public companies otherwise have wide discretion and may appoint members who have social ties to the CEO (Hoitash 2011; Larcker et al. 2006).

  2. In some instances, social ties between the CEO and members of the board of directors can be beneficial, because they can result in better communications and/or business opportunities. Thus, it is not necessarily desirable for all board members to be independent from the CEO.

  3. Our decision to use a news story from the business press to manipulate CEO Reputation in the context of executive compensation was influenced by research by Core et al. (2008). Their research documents that the press plays an important role in influencing executive compensation.

  4. Prior to creating the factor, the questions on whether the total amount of CEO compensation was excessive and on whether the Executive Compensation Committee was biased in favor of the CEO were reversed scored. Cronbach’s alpha for the four fairness questions is 0.86 which is an acceptable level.

  5. We also ran all tests using a fairness score created by averaging the four fairness questions together (rather than using the factor score). The results were qualitatively similar with all significant (insignificant) items still significant (insignificant) using the averaged score.

  6. Cronbach’s alpha for the three investment-related measures is .81 which is an acceptable level. The Eigenvalue of the first factor was 2.23 and the second factor was 0.47. These results support the creation one factor. We did not construct an average score because the three measures did not use the same response scale.

  7. As Tan and Yates (1995, p. 315) contend: “if a decision maker never acknowledges the existence of a particular dimension, then the decision maker cannot possibly respond to that dimension.”

  8. While we do not know why 14 participants did not answer the say-on-pay judgment, we speculate that this might have happened because the question was at the very bottom of the page and overlooked by these participants.

  9. We also analyzed H1 and H2 using only the 113 participants who also answered the fairness questions and were used to test H3 and H4. The results are substantially the same with all significant (insignificant) items using 116 participants remaining significant (insignificant) with only 113 participants.

  10. We compared demographics of the 30 dropped participants to the remaining 116 participants and found no significant differences in demographics between these two groups.

  11. We also ran a logistic regression with the say-on-pay judgment as the dependent variable and the Fairness factor as the independent variable. Fairness was a significant variable with a Wald χ 2 of 29.60 (two-tailed p value <0.01). These results corroborate the correlation results that support the first step of the mediation test.

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Acknowledgments

We would like to acknowledge the helpful comments of Linda Thorne (Associate Editor), two anonymous reviewers and participants at the 2013 Centre for Accounting Ethics Symposium held in Toronto, Canada.

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Authors and Affiliations

  1. W.P. Carey School of Business, Arizona State University, Phoenix, AZ, USA

    Steven E. Kaplan

  2. Thunderbird School of Global Management, Glendale, AZ, USA

    Janet A. Samuels

  3. Carroll School of Management, Boston College, Chestnut Hill, MA, USA

    Jeffrey Cohen

Authors
  1. Steven E. Kaplan
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  2. Janet A. Samuels
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  3. Jeffrey Cohen
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Correspondence to Steven E. Kaplan.

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Appendix: Say-on-Pay Judgment, Investment-Related Judgments, CEO Compensation Distributive Fairness Judgments, and CEO Compensation Procedural Fairness Judgments

Appendix: Say-on-Pay Judgment, Investment-Related Judgments, CEO Compensation Distributive Fairness Judgments, and CEO Compensation Procedural Fairness Judgments

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Kaplan, S.E., Samuels, J.A. & Cohen, J. An Examination of the Effect of CEO Social Ties and CEO Reputation on Nonprofessional Investors’ Say-on-Pay Judgments. J Bus Ethics 126, 103–117 (2015). https://doi.org/10.1007/s10551-013-1995-5

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