Author: Huasheng Gao (Nanyang Technological University), Michael Lemmon (University of Utah), and Kai Li (University of British Columbia)
Publisher: Social Science Research Network Working Paper Series
Date Published: April 2012
Having created a new database to examine the compensation packages of CEOs at publicly owned U.S. companies and of those at private firms, the authors of this paper dispel the conventional wisdom — echoed loudly during the Great Recession — that the CEOs of big public firms are paid too much by comparison.
As a group, public CEOs are indeed paid more than their private counterparts, almost twice as much, on average — US$2.97 million a year versus $1.57 million in total compensation, according to the new database. But when the authors compared CEO compensation at public and private companies of approximately the same size and industry share, the gap shrank dramatically. Much of the advantage for the public CEOs turns on industry, firm, and demographic differences — namely, they tend to have more experience and run larger, older companies. Their compensation also entails significantly more risk, in terms of restricted stock and options tied to firm performance.
When these and other differences are factored in, the public CEOs make just shy of 20 percent more, on average, than their private counterparts. Only a quarter of this much-reduced differential, or 5 percent, is attributable to cash, and the rest is tied to restricted stock and option grants. Even this premium is overstated, the authors say, because of “differences in liquidity, dividends, and employment risk between public and private firms.” When all is said and done, they conclude, public CEOs “are not overpaid.”
The researchers analyzed all U.S. private and public firms with compensation data available in the S&P Capital IQ database from 1999 to 2008, then retrieved stock option information from the ExecuComp database and SEC filings. In all, the researchers examined 1,938 private firms, with average assets of $273 million, and 5,333 public firms, with average assets of $467 million.
The analysis also revealed that the compensation of public CEOs was based much more than that of private CEOs on how well their firm performed. On average, equity-based pay (or restricted stock and options grants) was 24 percent of overall compensation at public firms, compared with 11 percent at private companies. And although private firms tended to be smaller, younger companies with weaker returns, higher cash flow volatility, slower growth, and fewer segments than public firms, their CEOs had been rewarded with a much larger ownership stake — about 13 percent, on average — than the CEOs’ public colleagues (6 percent).
The authors also examined succession searches that involved outside candidates and found that public CEOs faced a tougher labor market. Matching up 123 successions at private firms with the same number at public companies in the same industries and with similar sales levels, the authors found that 81 percent of outside hires at private firms came from other private firms, but that just 68 percent of CEOs appointed at public companies came from the public sector. And only 7 percent of new CEOS at private firms were hired from public companies.
To further demonstrate that the two types of firms structure their compensation packages in different ways, the authors tracked the 574 private companies in the sample that had changed their status through an initial public offering (IPO). They measured CEO compensation for a period of three years before and three years after the transition. Each company was matched to a control firm from the same industry that remained private and that posted similar sales the year before the IPO.