Research: Independent directors’ reputation incentives and executive pay tournaments
New research shows that reputation-conscious independent directors are more likely to support larger CEO pay gaps, using executive compensation as a tool to strengthen incentives, accountability, and firm performance.
Short Abstract
This research by Professor Trond Randøy, Aaron Afzali, and Lars Oxelheim finds that independent directors who care strongly about their professional reputation are more likely to support larger pay differences between the CEO and other senior executives. These larger pay gaps can motivate executives to compete for top leadership roles and take actions that improve company performance. The effect is strongest in firms where outside monitoring is weaker and performance is harder to assess. Overall, the study suggests that directors use executive pay structures as a governance tool to encourage performance and accountability.
Key Findings
- Reputation-focused directors support larger pay gaps. Companies with more independent directors who are concerned about their reputation tend to have larger pay gaps between the CEO and other top executives.
- The effect is stronger when oversight is limited. These directors are especially likely to favour larger pay gaps in firms with less external monitoring, such as those with higher information asymmetry, lower institutional ownership, less competition, or smaller size.
- Larger pay gaps can increase risk-taking. Stronger incentives to reach the CEO position are linked to greater managerial risk-taking and initiatives that may create value for the firm.
- Compensation is used as a governance tool. Independent directors appear to design executive pay structures in ways that strengthen incentives, demonstrate effective oversight, and enhance their own governance reputation.