CEO Compensation: US and other countries

by Ben Lorica (last updated Oct/2011)

In 2010 the average (mean) compensation of CEOs of companies in the S&P 500 was $11,358,445 (only $1,093,989 was in salary). As you can imagine one can take $11M and compare it with the salaries of other workers and produce a great infographic (see for example this page from the AFL-CIO). Along those lines, any discussion of CEO compensation usually includes a chart depicting the ratio between the pay of CEO's and workers (CEO-to-Worker pay ratios are usually based on surveys):

Ratio of Average CEO Pay to Average Worker pay: US
[ Sources: (1) and (2): Associated Press S&P 500 compensation survey and U.S. Department of Labor ]

The next step usually involves comparing CEO-to-Worker pay across countries, and the results you find using Google show that this ratio is much higher in the US. I omit those comparisons because I couldn't find descriptions of how (comparable) companies across countries were obtained.

US vs. other countries

I did find a paper with data I was comfortable with (Are US CEOs Still Paid More?), particularly since the source of comparable non-US companies was described in detail:

2006 fiscal year compensation data extracted from S&P's ExecuComp database (US), BoardEx (Non-US), or hand-collected from corporate filings, and excluding firms with less than $100 million in 2005 revenues. .. We exclude CEOs in their first years and those for whom annual revenues are not found in Worldscope to compute the CEO pay statistics. CEO Pay is defined as the sum of salaries, bonuses (including all non-equity incentives), benefits, and grantdate values for stock options, restricted stock, and performance shares. .. our analyses below are based on a final sample of 1,532 US CEOs and 1,480 non-US CEOs.

In comparing CEO compensation it's important to account for factors that affect the total pay package. As an example, assume for the moment the stereotype that Wall Street executives are highly compensated relative to their peers in other sectors. Then using simple averages to compare CEO compensation between the US and another country with a much smaller financial sector, is probably not optimal. Private sector executive compensation committees look at salaries of other executives within the same sector. Translating that practice to a data set of 1,532 US CEOs and 1,480 non-US CEOs requires statistical models that control for a series of factors that affect size of compensation.

In reaching our conclusion that the US Pay Premium has become modest (or insignificant), we control not only for the "usual" firm-specific characteristics (e.g., industry, firm size, volatility, and performance) but also for two sets of characteristics that systematically differ across countries: ownership and board structure. Compared to non-US firms, US firms tend to have higher institutional ownership and more independent boards, factors associated with both higher pay and increased use of equity-based compensation. In addition, shareholdings in US firms tend to be less dominated by "insiders" (such as large- block family shareholders), factors associated with lower pay and reduced use of equity-based compensation.

After adjusting for a series of factors, US premium for CEO compensation has all but disappeared: dropping to (statistically insignificant) values of 2% in 2007 and 14% in 2008. US premium for the equity component of CEO pay, was 9% in 2007 and 13% in 2008. It will interesting to see data for years after 2008, to see if the US premium for CEO pay recovered after the financial crisis. In the next section we examine similar statistical models (and similar results) for Risk-adjusted compensation.

Time trends in the US Pay Premium and Equity Pay Premium
(CEO Pay controlling for firm, ownership, and board characteristics)
[ Source: Are US CEOs Still Paid More? (Table 3 & Figure 5)]

Results by Country: Median, Mean, and Risk-adjusted Compensation

The sample size was large enough that one can compare the US to individual countries. In the graph below, Non-US refers to the values obtained when computed for all non-US companies in the sample. (To facilitate comparison of US vs. non-US, I highlight both with a "blue dot".) You can choose modes of comparison using the drop-down menu. Here are some observations:

Median CEO compensation by country => $3.3M for the US and $1.6M for the non-US countries.

Mean CEO compensation by country => $5.5M for the US and $2.8M for the non-US countries.

The results for Median/Mean CEO pay are consistent with previous research suggesting that US CEOs get paid about twice their non-US peers, and that equity is a higher portion of their compensation package: on average equity is about 39% for US compared to 22% for non-US CEOs. Since equity is a larger portion of their compensation, ".. it is possible that the remaining US pay premium reflects a compensating differential for the increased risk of US pay packages."

The researchers define Risk-adjusted pay to be the amount of compensation after all non-tradable options granted to an undiversified risk-averse executive, have been replaced with equivalent¹ riskless cash compensation the executive would exchange for the options. (By making assumptions about the distribution of future stock prices and utility function over wealth, one can find the "certainty equivalent" value of options.) The researchers then built a statistical model² to predict Risk-adjusted CEO pay, after one controls for firm, ownership, & board characteristics.

Risk-adjusted CEO pay, for a hypothetical firm with $1B in sales => $2M for the US and $1.79M for the non-US countries. In addition the Anglo-Saxon nations (the US, UK, Ireland, Australia, Canada) yield comparable results. In general US pay premium "largely disappears" after controlling for the relative riskiness of US pay packages.

To give you a sense of the coverage of the data set in each country I included a column that reflects the combined market capitalization of companies in the sample:

"% of Market Cap" is computed for each country as the market capitalization of all firms with CEO pay data divided by the total market capitalization of all firms in Datastream/Worldscope."

2006 CEO Compensation by Country
[ Source: Are US CEOs Still Paid More? (Table 1 & Figure 2) ]

Hiring External CEO's

I close by highlighting a recent academic study on the performance of externally-hired CEO's. The researchers found that externally-hired CEO's command a pay premiun that is negatively correlated to future performance!

"Prior research finds that firms tend to select external CEO hires from companies with superior past performance and that this past performance is associated with a compensation premium in the hiring firm. We test whether this pay premium is associated with future performance in the hiring firm. We find that the pay premium for predecessor firm performance, though economically significant, does not predict higher performance in hiring firms. In fact, we document a negative relation between this pay premium and future performance. We also find external CEOs' prior firm performance is not associated with a pay premium in the years subsequent to the year of hire. Finally, we find that measures of board inattentiveness predict the degree to which boards rely on prior firm performance to evaluate external CEO candidates. Overall, our results are consistent with the view that boards over-weight executives' prior firm performance when evaluating external CEO candidates."

Related resources:

U.S. Income and Wealth Inequality: Share of Top Earners (1917-2008)

Wall Street Bonuses by the numbers

U.S. Federal Income & Capital Gains Tax Rates, and the Buffett Rule

Campaign Finance & Lobbying by the Numbers

Charts for Decision 2012

(1) From page 15: "The results .. are robust to alternative definitions of safe wealth, equity premiums, and option terms: under all specifications, the implied US pay premium is monotonically decreasing in risk aversion, and becomes insignificant at relatively low levels of risk aversion after controlling for firm, ownership, and board characteristics. Calculating more precise estimates of risk-adjusted compensation for individual CEOs requires data unavailable to us, including details of executive outside wealth and measures of individual risk aversion."

(2) From page 15: "Risk-adjusted pay is estimated using the 'certainty equivalence' approach, assuming relative risk aversion of 2; safe wealth is assumed to be the greater of $5 million or four times total compensation. After adjusting for the risk associated with equity-based compensation (as well as firm, ownership, and board characteristics), CEO pay in the United States is statistically significantly less than CEO pay in the United Kingdom and Australia, and insignificantly different from CEO pay in Canada, Italy and Ireland."s

(3) See Mark Cuban's post on Executive compensation.

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