CEO Compensation as a Process and a Product of Negotiation

The purpose of this theory paper is to extend our understanding of CEO compensation by looking into the CEO pay-setting process. Particularly, a process model is proposed to specify the interaction between situational indicators, process variables, contextual factors and CEO pay.With regard to methodology, a modest review the major theories that are driving the field of CEO compensation study reveals several interesting findings. These models or perspectives provide valuable but incomplete understanding of the multifaceted phenomenon. Especially, the realm of CEO pay-setting process is still unexplored. A process model of CEO compensation is developed to fill in this gap. Our inquiry indicated that CEO compensation involves a negotiation between a CEO and a principal. Negotiated CEO pay is better predicted by CEO aspirations and principal reservations, rather than economic indicators. CEO power and the institutional environment have a moderating effect. The practical contribution of this paper is straightforward. The study suggests that a better theory is critically in demand in order to improve effectiveness of corporate governance. We underscore that a real challenge for a principal in influencing CEO pay is to anticipate CEO aspirations and to monitor the gaps between CEO aspirations and principal reservations, rather than to control economic indicators. Unfortunately, until now we have very limited information about principal reservation and CEO aspiration. This inquiry seeks to make a difference by moving CEO compensation research into a fruitful direction. To our knowledge, this inquiry is the first attempt that provides systematic explanation as to how and why situational indicators do not directly influence the negotiated CEO pay. The newly proposed model is much realistic, much integrative and much dynamic, compared with existing conceptualizations. Eight propositions are presented to guide empirical research as well as future theory development