In his Research for the Real World column in World at Work’s Workspan magazine, Kevin Hallock asserts that CEO pay is positively correlated with firm size, even when controlling for a number of other variables. Should we be surprised? I don’t think so.
Hallock’s assertion is based on research he did for The Conference Board using CEO pay data for 2,300 US companies. Total compensation (salary, bonus, equity) ranged from $878K in the lowest revenue decile to $10.2 million in the highest revenue decile. The relationship holds even when other variables are introduced into the analysis – firm-level variables such as industry, profitability, R&D expense and individual-level variables such as age and experience.
Hallock introduces the notion of elasticity – the percentage change in one variable associated with a percentage change in another – and estimates the elasticity of CEO pay with respect to firm revenue to be 0.3. The elasticity is ostensibly the coefficient on the revenue variable in a regression that includes the control variables mentioned above.
The quantification of the relationship (for this specific data set) is valuable. However, we should not be surprised that CEO pay increases with firm size. Why not?
Compensation is based largely on job scope and performance. In the case of CEOs, a larger organization is essentially larger job scope. If a firm acquires another firm, the acquiring firm’s CEO’s pay will either stay the same or increase (maybe not immediately, but you can be sure that the case will be made and viewed favorably by the compensation committee). The pay premium for increased size reflects the increased responsibility and risk that the CEO now bears.
In practical terms, compensation levels are determined through salary surveys. Most salary surveys segment participation by firm size, recognizing that pay level vary across size categories. It’s a little bit of “chicken and egg” – did the surveys simply capture the extant firm size vs. pay relationship (presumably the first ever survey did) or did survey data subsequently drive the relationship?
Are there any avenues for research that might throw additional light onto the correlation of firm size with pay? Here are a few suggestions.
- Hallock’s results are for CEO’s in US companies, so a natural question is whether these results hold outside the US and if so whether the elasticity of CEO pay with respect to firm size varies by geography. What specific factors drive the variation?
- It’s likely that the relationship holds for other executives, but what about non-executive roles? Surely there are some benchmark roles whose pay is not as strongly correlated to size as is executives’ pay. One might surmise that the HR function’s pay does not increase as dramatically as say the risk management function’s pay across investment banks.
- Does it matter how you measure firm size? Hallock’s work is based on revenue. Do other measures of size such as assets, market capitalization or number of employees exhibit a stronger relationship? Hallock claims that the relationship is robust to the choice of size metric. Perhaps one metric is a better predictor of pay? Survey vendors take note.
- Does the macro relationship (i.e., at the firm level) hold at the micro level (i.e., divisions and departments within a company)? It ought to, if our rationale above (job scope) is correct.
- How does the elasticity of pay with respect to firm size vary with firm size? I suspect that Hallock reports elasticities at the mean; elasticities are different at different levels of firm size.
- Has the relationship between firm size and pay evolved over time?
There remains plenty of work to be done to fully characterize the relationship between firm size and compensation. Why is this important? We’re always seeking to understandd what drives pay and therefore be in a position to predict what the “right” pay level should be.
Survey vendors that have run compensation surveys across multiple industries for many years are in a position to examine some of these questions. It’s a pity that they tend not to capitalize on the vast treasure trove of information they possess. I’m sure their customers would be interested in some cross-company analytics such as elasticities of pay with respect to firm or division size.
World at Work is to be commended for including a research-oriented column in Workspan and Hallock is to commended for introducing interesting ideas.