Author Information : Yaniv Grinstein (Cornell University and IDC Herzliya)
David Weinbaum (Whitman School of Management, Syracuse University)
Nir Yehuda (University of Texas at Dallas)
Year of Publication : Contemporary Accounting Research (forthcoming in 2018)
Summary of Findings : Executive compensation disclosure rules can have important -- and sometimes unintended -- consequences on pay practices in corporations.
Research Questions : How do changes in disclosure regulation affect perk awards in public U.S. firms?
What are possible substitution effects between perks and other compensation components?
What we know : This paper is relevant to economists interested in executive compensation. It also has important implications for policy makers and corporations, along with their shareholders, boards and executives.
Novel Findings : People generally think that more disclosure and transparency are always better. We show that this is not necessarily the case when it comes to executive compensation: mandating disclosure is costly and can have unintended consequences. In the words of Warren Buffett, “American shareholders are paying a significant price because they get to look at that proxy statement each year” essentially because “no CEO looks at a proxy statement and comes away saying I should be paid less.”
Implications for Policy: From a policy perspective, our study contributes to the debate on the usefulness of compensation disclosure rules. The adoption of the new disclosure standards by the SEC was foreshadowed by a number of SEC actions in the years leading up to the proposal. These actions were taken amid several well publicized alleged abuses by certain corporations and their executives, in response to which institutional shareholder activists had expressed concern. Our results indicate that the enhanced disclosure rules adopted by the SEC led to disclosure of information that is material to shareholder value.
Full Citations : Grinstein, Y., D. Weinbaum, and N. Yehuda, “The Economic Consequences of Perk Disclosure,” Contemporary Accounting Research, forthcoming.
Abstract : In December 2006 the SEC issued new rules requiring enhanced disclosure, by public U.S. firms, of perquisites granted to their executives. We study how the changes in disclosure regulation affected perk awards, and we investigate possible substitution effects between perks and other compensation components. We study the effects of the new rules on firms that did not disclose perks until after the rules went into effect, as well as on firms that were already disclosing their perks.
The rules applied to perquisites granted in fiscal year 2006 and thereafter. Because the rules were implemented quickly, the perks disclosed for 2006 reflect the arrangements firms made under prior disclosure rules: firms could not revise perks to reflect the new rules until 2007. This allows us to use the year the regulation went into effect as a benchmark year in which firms disclose perks that have not been adjusted as a result of the regulation.
We identify two main economic mechanisms through which disclosure regulation affects perk award practices: changes in the cost of disclosure, and enhanced monitoring of executive pay. The first mechanism—changes in the cost of disclosure—encompasses both increases and decreases in cost. The 2006 rule change likely imposes costs on firms that disclose for the first time as well as their CEOs. In firms that were already reporting perks, however, the disclosure regulation may reduce the cost of disclosure because the increased visibility of perk awards improves investors’ and third parties’ knowledge of the entire distribution of perks awarded.
The second main mechanism through which disclosure regulation affects perk award practices is enhanced monitoring of executive pay. If the rules lead to increased transparency and greater investor scrutiny, this should allow for better monitoring.
For firms that disclose for the first time in 2006, we find that perks decrease in 2007, reflecting both the costs of increased disclosure and enhanced monitoring. This decrease in perks is offset by higher levels of non-perk (i.e., cash) compensation, however. In other words, some corporations began to substitute cash for perks to avoid disclosure.
We also find that the effect of perk disclosure by formerly non-disclosing firms in 2006 leads to higher perks in 2007 for firms that were disclosing perks prior to the rule change: corporations that had already been disclosing perks before the new rules went into effect actually increase perk awards after the rule change. Warren Buffett alluded to a similar dynamic during a recent interview, and said: “There is this ratcheting up and ironically the proxy rules have made it worse because the proxy rules have been a guideline to every CEO as to what the other guy is getting. Envy is a huge factor.” Consistent with this, we find that firms that awarded perks that were lower than their peers’ in 2006 increased their awards in 2007. In contrast, firms that awarded perks that were higher than their peers’ in 2006 made no significant change in 2007.
A paper recently accepted by Contemporary Accounting Research shows executive compensation disclosure rules can have important — and sometimes unintended — consequences on pay practices in corporations.
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