The Effect of Social Interactions on Executive Compensation

Abstract

We investigate whether and how executives’ social interactions affect their compensation. Using the social networks among 2,936 chief executive officers (CEOs) during 1999-2008, we report that socially connected CEOs receive significantly more similar compensation than non-connected CEOs. This result is robust to the inclusion of executive- and firm-fixed effects. We further find that CEO compensation responds to a peer’s change in pay caused by industry performance, especially if that change in pay is positive and the firm is suffering from weak corporate governance. We interpret these results as consistent with the notion that relative earnings concerns within social networks affect negotiations about compensation. Finally, we find that the past practice of backdating stock option grants spread across social networks, suggesting that social networks serve as a conduit for interpersonal information flow about compensation practices. Overall, our evidence suggests that peer effects in CEO compensation is due to both sharing of compensation matters and efforts to “keep up with the Joneses” within the network.

Keywords: executive compensation, social networks, option backdating, Pay for Luck, peer groups

JEL Classification: J31, J33, G34, M52