The political leanings of a CEO can affect their initial pay package, according to new research from the University of Notre Dame.
Research and corporate governance practices generally recommend compensating a risk-averse CEO with more performance-based pay to incentivize risk taking. Earlier research has shown that political affiliation is an indicator of a CEO’s willingness to take risk: liberal CEOs are bigger risk-takers than their conservative counterparts.
Timothy Hubbard, assistant professor of management at Notre Dame’s Mendoza College of Business, wanted to learn whether conservative CEOs receive more performance-based pay to incentivize them to take more risks for the firm, but instead, Hubbard and his fellow researchers found the opposite.
Hubbard explains that it happens because executives join companies that pay the way they prefer, and boards tailor pay packages for CEOs.
“Our study shows new CEO compensation mirrors their existing risk preferences,” Hubbard said in a news release. “CEOs are attracted to firms that offered the prior CEO a pay package that is similar to what they would naturally want to have — or appeals to their risk tolerance. And there’s a little bit of tailoring happening where the new CEO is receiving a different pay package based on their personal risk preferences as measured through their political orientation.”
Researchers found that conservative CEOs don’t react to performance-based pay, but liberal CEOs tend to change their companies a lot more when performance-based pay is increased. “This leaves open the question for boards and shareholders: How do you encourage more conservative-leaning CEOs to enact strategic change?,” Hubbard said. “This study shows that increasing performance-based pay does not result in conservatives enacting strategic change.”
Hubbard, along with Scott Graffin and Eric Lee from the University of Georgia and Dane Christensen from the University of Oregon, looked at 739 CEOs at 485 companies in the S&P 500 between 1995 and 2011 and measured CEOs’ political orientation based on their political giving. Their performance-based pay was determined by how much of their salary was conditional on firm performance — stock options, bonuses — compared to their salaries. To investigate the effect of political orientation and initial pay on change, they looked at changes in resource allocation patterns at firms, their level of merger activity and changes in research and development.
“The influence of CEO risk tolerance on initial pay packages” is forthcoming in Strategic Management Journal.