The affect of recent requirements on Compensation and Board Structure - Harvard Law School Corporate Governance Blog, June 18, 2008

(Editor’s note: This post comes to us from Vidhi Chhaochharia of the University of Miami and Yaniv Grinstein of Cornell University. Their article was recently accepted for publication in the Journal of Finance.)

The purpose of this article is to examine how the new board
requirements that were enacted in response to corporate scandals in
2001 and 2002 affected compensation decisions. We use the
difference-in-difference approach to compare changes in compensation
between firms that were already complying with these requirements and
firms that were not complying with them. Our sample consists of 865
firms that belong to the S&P 1500 index for the period 2000 to
2005. To measure level of compliance, we focus on three board structure
variables that were required by the rules: the requirement for a
majority of independent directors on a single board, the requirement
for an independent nominating committee, and the requirement for an
independent compensation committee.

We find that firms that did not comply with these requirements
significantly decreased CEO compensation in the period after the rules
went into effect, compared to the complying firms. The decrease is on
the order of 17%, after taking into account performance, size, time
varying shocks to different industries during that period, firm fixed
effects, and other variables affecting compensation that changed during
that time. We also find that the one requirement that is strongly
associated with a drop in compensation is the requirement that the
majority of board members be independent, and that the significant
relative drop in compensation comes from the decrease in the bonus and
the stock based compensation. We also find that the decrease in
compensation is particularly pronounced in the subset of affected firms
with no outside block holder on the board and in affected firms with
low concentration of institutional investors. In short, our results
suggest that the new board requirements affected CEO compensation
decisions.

The full paper is available for download here.