One-third of S&P 1500 CEOs reduced their base salary in 2020 as the onset of the coronavirus pandemic caused widespread economic disruption. These pay cuts were often accompanied by press releases that emphasized notions of CEOs “leading from the front,” “being all in this together,” and “sharing the pain” of the pandemic with employees. In a new article, we document that a more complex adjustment to CEO pay occurred during this time.  In a controlled analysis of executive compensation, we find that, while many CEO base salaries declined during 2020, the total compensation for all CEOs increased by nearly 40 percent, on average, regardless of whether their base salary was reduced or not.

So why was base salary the target of CEO pay reductions during 2020, and how did CEOs who took a cut manage to end 2020 with just as much of an increase in total compensation as those who did not? We analyze CEO salary cuts from the perspective of managerial power, which offers answers to both questions.

Under the managerial power theory of executive compensation (Bebchuk and Fried, 2004), CEOs engage in rent extraction by influencing the supposedly  independent pay-setting process undertaken by their boards to receive pay higher than shareholders would consider optimal. The amount of rent extraction is constrained by outrage costs – the economic, social, and reputational harm to the directors and the executive if outsiders perceive the CEO’s pay excessive.

The pandemic highlighted perceived disparities in executive compensation relative to rank-and-file workers, many of whom lost their jobs or were furloughed.  The managerial power perspective suggests that, rather than being solely a benevolent action taken in solidarity with workers, CEO salary reductions could also have resulted from increased stakeholder outrage over such disparities. In line with this perspective, the public focused on base salary when considering variations in CEO compensation because it is an easily understood component of CEO pay. A reduction in base salary would therefore better appease a broad stakeholder base less familiar with the intricacies of executive compensation contracts.

The fact that CEOs who took salary cuts were not worse off than other CEOs at the end of 2020 in terms of total compensation implies that the base salary cuts must have been offset through an increase in other components of CEO pay such as bonuses, stock awards, and options.  The managerial power framework offers an explanation for why different forms of pay may have increased during the pandemic: pay camouflaging.

Camouflaging in the context of executive compensation refers to practices that seek to obscure or legitimize rent extraction. Our analysis shows that around half of all CEOs who took salary cuts maintained or increased their total compensation, at the risk of provoking outrage in 2020, by receiving an increase in other forms of compensation. Camouflaging parts of their compensation to avoid scrutiny implies a reallocation of forgone CEO base salary to less transparent components of compensation. We examine changes in each component of CEO pay in 2020 and find an average 131 percentage point increase in the nebulous category of compensation labelled “other.” This increase appears to substantially offset the reduction in base salary that was widely reported by CEOs who took salary cuts in 2020.

“Other compensation” is a relatively obscure item in annual proxy filings, capturing compensation not reported in one of the other reporting categories, representing perquisites provided to the CEO that the firm explicitly pays for.  Common perks in this category include the cost of life insurance premia and healthcare related benefits; personal security; club membership fees; the personal use of corporate-owned facilities and assets, such as real estate, cars and planes; as well as corporate contributions to 401(k) accounts. Such forms of compensation are not subject to standard methods of reporting, and they are typically included at the end of the discussion on executive compensation in varying degrees of detail.

Central to the managerial power theory is that executives have power to influence their own pay. That is, unlike what would happen under an optimal contracting model of executive compensation, the board of directors does not operate at arm’s length in determining pay arrangements (Bebchuk, Fried and Walker, 2002). Using several measures of managerial power and corporate governance, we show that offsetting salary cuts through higher “other compensation” is most common among powerful CEOs. Our main measure of CEO power is the “CEO Pay Slice.” This is calculated as the proportion of aggregate compensation of a firm’s top five executives paid to the CEO, based on data in the year prior to the pandemic. Powerful CEOs tend to be paid well above the next highest-ranking executive, which would be reflected in a large CEO pay slice. While a base salary decrease of 19 percent is observed for powerful CEOs who take salary cuts, their variable salary increases by approximately 20 percent and is principally driven by a large and significant increase in compensation classified as “other.” On the other hand, the total compensation of less powerful CEOs whose base salary was reduced fell nearly 25 percent.

Given the dominance of the optimal contracting model in academic research, our paper provides an important counterpoint to the much-debated topic of executive compensation. Our findings suggest that closer scrutiny of all aspects of CEO compensation is important in limiting excessive CEO pay packages and identifying inefficient arrangements.

Our final piece of analysis assesses how the quality of the firm’s corporate governance can constrain CEO power.  Pointing to the important role that corporate governance can play in detecting and monitoring CEO behavior, our results show that CEOs of firms with weaker corporate governance, low board independence, and busy boards often engage in pay camouflaging and avoid any significant loss in income. This highlights the critical role of strong corporate governance during crises, not only in organizing the crisis response but also in protecting the interests of stakeholders.

This post comes to us from Attila Balogh at Cornell University’s SC Johnson College of Business, Danika Wright at The University of Sydney, and Jason Zein at UNSW Business School. It is based on their recent article, “Does Stakeholder Outrage Determine Executive Pay?” available here.