Board Information Processing Capacity and CEO Pay-for-Performance Sensitivity

We develop an agency/information processing theory of board effectiveness to examine board – CEO pay relations. We theorize that board-level information processing capacity affects CEO pay-for-performance sensitivity because boards with limited information processing capacity will prefer to use outcome-based control that links CEO pays more closely to firm performance. Using a longitudinal sample of Standard and Poor’s (S&P) large-, medium-, and small-cap manufacturing firms in the United States over the years 1998 to 2003, we find support for our theory. Smaller boards and those that meet less frequently tend to exhibit greater CEO pay-for-performance sensitivity and this tendency is even greater when boards are more independent. Our study suggests that the board effectiveness should be assessed from both independence and information processing perspectives