Abstract
Research Question/Issue This study applies the statistical properties of Benford's Law to CEO pay. Benford's “Law” states that in an unbiased dataset, the first digit values are usually unequally allocated when considering the logical expectations of equal distribution. In this study we question whether the striking empirical properties of Benford's Law could be used to analyze the negotiating power and preferences of CEOs. We argue that performance‐based or market‐ determined compensations should follow Benford's Law, demonstrating no direct negotiation by the CEOs. Conversely, deviation from Benford's Law could reveal CEO negotiating power or even preference.
Research Findings/Insights Our analysis shows that market‐determined “Option Fair Value” (the dollar value of stock options when exercised) conforms closely to Benford's Law, as opposed to “Salary”, which is fully negotiated. “Bonus”, “Option Award”, and “Total Compensation” are generally also largely consistent with Benford's Law, but with some exceptions. We interpret these exceptions as negotiation by the CEOs. Surprisingly, we found that CEOs prefer to be paid in round figure values, especially “5”. We use Benford's Law to study the negotiating powers of CEOs vs. that of other executives. Finally, we compare the negotiating tactics of CEOs before and after SOX and analyze the impact of firm size on their compensation.
Theoretical/Academic Implications This study introduces Benford's Law and its applications within the corporate governance literature.
Practitioner/Policy Implications This method could be used by academics, industry and regulators to uncover compensation patterns within large business departments and/or organizations or even entire industry segments.
7 | CONCLUSIONS AND LIMITATIONS
In this study, we contributed to the corporate governance literature by proposing the usage of Benford's Law in explaining CEO pay. In the first part of the analysis, we established that Benford's Law is a suitable method for differentiating between performance‐based or market‐linked pay and directly negotiated compensation. Having proven its effectiveness, we next proposed the usage of Benford's Law in testing some interesting executive compensation‐related problems. In the second part of our empirical study we therefore applied Benford's Law to shed light on three specifically related issues, namely (1) Is there a difference between the compensation negotiating powers of CEOs and those of Other Executives?; (2) Is there a difference between the compensation negotiating tactics of CEOs before and after the implementation of SOX; and (3) Is there a difference between small‐firm CEOs and large‐firm CEOs in the way in which they negotiate their fixed compensation?
