How Much Does the CEO Matter?

The Role of Managerial Discretion in the Setting of CEO Compensation

(Findelstein Boyd 1998 AMJ)

Summary by Ricardo Ortega

Managerial Discretion and CEO Compensation

Managerial discretion refers to the range of options that managers have when making strategic choices for the firms they
run. CEO impact on organizational outcome is increased in these high-discretion contexts. The following dimensions are
taking into account to define the grade of discretion.

Regulation: CEOs in regulated industries have a limited set of options for their existing business. Firms in a less regulated
environment will place a greater premium on acquiring a more capable CEO. Since the less effect on outcome for CEOs in
regulated firms and the uncertainty and risk needed to run less regulated firms those CEOs in the latter tend to earn more.

Investment Opportunities: CEOs able to take risk in multiple investment opportunities tend to earn more than those who
cant. Eventually, CEOs that earn more due to these investments tend to be more skilled which give them a higher level of
pay. Empirical research also shows a correlation between higher salaries and high-growth firms. The investment
opportunities are usually measured in terms of growth which is a key dimension for discretion and sometimes for regulation.

Product Differentiability: Other dimensions apart from the previous ones have little research but conceptual reasoning
helps to understand and relate them to CEO compensation. When a firms products or services are more differentiated a
CEO is expected to have a broader knowledge and ability to perform more competitively. Such abilities and skills come at
a price. The complexity and risk of his duty results in a higher compensation. (R&D Intensity and Advertising Intensity are
significant at predicting CEO compensation).

Industry Structure: Industries where CEOs have fewer choices to make (like oligopolistic industries) not necessarily require
high capable CEOs to address a great range of opportunities and challenges of highly competitive industries. Discretion is
greater in high concentrated industries resulting in higher CEO pay.

Demand Instability: CEOs facing changing and unstable environment makes his job harder. Therefore CEOs who can
deal with such complexity need to be compensated adequately both for his ability and for the added risk that accompanies
managing these environments.

Capital Intensity: This tend to create rigidity making it difficult to accommodate changes in strategy. Therefore firms
offering a CEO more discretion, his job tend to be more complex and involve greater risk which end up in higher payment.

Summarizing the first hypothesis: The greater level of discretion, the greater the CEO compensation.

Managerial Discretion, CEO Compensation and Firm Performance: The apparent contingency theory present in this
section makes logic that association between CEO discretion and pay is higher in high performance firms. Which is the
hypothesis 2.

METHODS: The sample is sufficiently randomized so the results are generalizable.

Predictor and Outcome Variables: Discretion, for this variable the level to measure this was at the firm level and not
industry level analysis. This variable has the following seven indicators: Market growth, R&D and advertising intensity,
demand instability, capital intensity, concentration, regulation.

CEO Compensation, two primary elements of CEO pay are total cash compensation and long-term or deferred income.
Those were used as indicators to construct the CEO compensation.
Control Variables: Prior firm performance: Using 3 indicators of ROE, ROA and Tobins q.
Firm size: Two indicators, net sales and total assets.
CEO Factors: CEO equity and CEO tenure are relevant factors of the pay equation. Those control variables have a positive
relationship with levels of CEO pay.
RESULTS: The findings have strong support for both hypothesis.

DISCUSSION: Compensation is one of the most important incentive that exists in organizations and impacts managerial
decision making and strategy. A proper match in CEO pay and discretion has now a more important role than previously
recognized.