The Interplay between Director Compensation and CEO Compensation

This paper empirically examines the determinants of director compensation and CEO compensation and investigates whether director compensation has an effect on CEO compensation. Based on 713 firms (or 2,852 firm-years) between 2007 and 2010, we find that CEO tenure is related to the ability of the CEO in influencing the board’s pay determination process. However, sitting on the board does not strengthen the CEO’s power over the board during the pay negotiation process. More importantly, we find evidence of a mutual back scratching relationship between CEO and the board of directors. Excess director compensation and CEO compensation are positively related. The results thus support Jensen’s (1993) argument that as the CEO is involved in the selection of directors, the monitoring role of the board of directors becomes less effective.