Outside CEO directors on compensation committees: whose side are they on?

Purpose – The purpose of this paper is to examine whether outside CEO directors sympathize with the company CEO due to their similar positions and prestige, and make decisions in favor of the company CEO. Specifically, the authors investigate how outside CEO directors serving on the compensation committee influence CEO compensation. Design/methodology/approach – The authors investigate how outside CEO directors on the compensation committee impact the level and pay-for-performance sensitivity of CEO compensation. In addition, the relation between excess CEO compensation (attributable to outside CEO directors) and future firm-operating performance is examined. Findings – It is found that outside CEO directors on the compensation committee are associated with higher CEO compensation. However, excess CEO compensation attributable to outside CEO directors leads to poor future firm-operating performance. Outside CEO directors are associated with higher CEO pay-for-performance sensitivity when the company experiences positive stock returns, but do not impact pay-for-performance sensitivity when firm performance is poor. Finally, when the company CEO has more influence on the board, outside CEO directors are more likely to serve on the compensation committee. Originality/value – The paper is among the first to show that having outside CEO directors on the compensation committee might create agency problems and is costly to shareholders. The findings of the authors' study are relevant to current efforts of regulators and private sectors to enhance oversight of executive compensation.