Some corporate boards are exclusive networks of corporate acquaintances and cannot be trusted to keep CEO pay in check, according to a study by researchers at the Ted Rogers School of Management at Ryerson University in Toronto.
Prof. Fei Song of Ryerson and Chen-Bo Zhong, an associate professor at the Rotman School of Management, point out that boards often seek expertise from CEOs of other firms.
That gives them an incentive to seek higher pay for the company CEO, because any such recommendation will have the effect of boosting their own pay, the researchers found.
- CEO pay increased at twice the rate for average Canadian since 2008
- Canadian CEO pay jumped 11% in 2013
There has been much criticism about the steep climb in CEO pay in North America since sunshine laws forced publicly listed corporations to reveal what they pay their top talent.
The escalating pay for senior executives is often justified as a way of retaining skilled people, or simply a recommendation from a board of directors that has seen first-hand how the person at the top does the job.
"However, people who make up these boards are often CEOs of other companies themselves and are more likely to receive higher compensation packages because of this exclusive network," Song said.
High CEO pay takes resources away from other areas of the company, including investment and employee pay, as well as shareholder returns.
"If executives of corporations receive a higher compensation, they may be taking the company's revenue from the shareholders' pockets and paying it to themselves," Song said.
Her study involved researching the behaviour of people who belong to exclusive networks, like the tight circles that make up many boards of directors.
To test ethical behaviour in networks, she put research subjects into groups and asked them to divvy up a pot of money that would benefit either people within their network or those they don't know.
"Individuals are more likely to cross moral boundaries and engage in deception for another person in the cyclic network than they would for themselves," Song said in her paper, published in the Journal of Economic Behaviour and Organization.
She said people who belong to these tight circles may believe "if everyone 'helps' everyone else, everyone will be better off."
Not an obvious conflict
For some players, a sense of accountability and responsibility might outweigh the incentive to approve a pay raise for someone in a similar position to their own, she said.
She admitted it's difficult to track these networks in the business world, and shareholders may be unaware of their effect on decisions made at the board level.
Such arrangements are not always obvious conflicts of interest, because the CEO of company A may sit on the board of company B and the CEO of B on the board of C and the CEO of C in turn on the board of A.
"You scratch his back, he scratches mine and I'll scratch yours" is how she describes it.
Song recommends giving shareholders more powers to monitor board meetings to try to check the tendency to pay CEOs elevated compensation.
York University's Richard LeBlanc says there may be other ways of shaking up these tight circles of friends by demanding more diversity on boards and limiting the terms of directors.