How Board Quality Affects CEO and Executive Team Pay

Board quality is likely to have an important influence on CEO compensation. However, there has been little investigation in the literature. We examine the relationship between the quality of boards, pay and pay allocation (incentive versus fixed, CEO versus executives below CEO) of executive teams. We hypothesize that the higher the quality of boards, the better the monitoring services of the boards; better monitoring increases the chance of finding the current executives' true quality and of replacing underperforming executives; better monitoring can also decrease total pay by reducing information costs (e.g. efficiency wage and overpayment from adverse selection) and incentive pay. Our empirical analysis uses three different proxies for director quality: (1) the size of firms that board members hold as external directors (social capital of directors), (2) the number of external directorships held by board members, and (3) the proportion of board members holding multiple directorships. The values (2) and (3) measure the amount of time that directors spend per firm. Our findings are as follows: The more valuable the social capital of outside directors, the less (more) incentive (fixed) pay to top executives including CEO. The busier the average directors of a board are, the higher the total and incentive pay. In addition, the less independent the compensation committee, the higher the CEO pay slice (CPS). The increased CPS results from both incentives and fixed pay. Such a relationship is stronger when a CEO is also the chair of the board. We conclude that the quality of boards is an important determinant of the pay structure of executive teams