Recursive relationships in executive compensation

Abstract

Asian businesses in the 21st century will learn from the experience of their US counterparts in promoting better governance of executive compensation in publicly traded companies. In this paper we examine the membership of the compensation peer groups for 121 of the largest US-headquartered, publicly-traded firms. We find that the existence of self-reinforcing recursive relationships through peer groups is pervasive. We illustrate that the effects from these relationships could be very large. Finally, we measure the association between the size of a firm’s recursive effect and that firm’s average compensation for named executives. The association is large, positive, and statistically significant. Thus our findings suggest that recursive relationships arising from the widespread use of peer-group benchmarking is affecting executive compensation levels for many large US firms. These findings should alert Asian businesses to the effect that the practice of peer-group benchmarking may have on executive compensation.