Differences in CEO compensation under large and small institutional ownership

Author:Onur Kemal Tosun
Publication Date:01 Sep 2020
Eur Financ Manag. 2020;26:10311058. wileyonlinelibrary.com/journal/eufm © 2019 John Wiley & Sons Ltd.
DOI: 10.1111/eufm.12252
Differences in CEO compensation under large
and small institutional ownership
Onur Kemal Tosun
Cardiff Business School, Cardiff
University, Cardiff, UK
Onur Kemal Tosun, Assistant Professor,
Cardiff Business School, Cardiff
University, Cardiff CF103EU, UK.
Email: TosunO@cardiff.ac.uk
I examine the influence of large and small institutional
investors on different components of chief executive officer
(CEO) compensation, using US data for 20062015. An
increase in large institutional ownership reduces total pay
and current incentive compensation (i.e., options, stocks,
bonus pay), whereas small institutional investors lower
longterm incentive pay (i.e., pension, deferred pay, stock
incentive pay). These findings are consistent with manage-
rial agency theory and the substitution of incentive pay
by institutional monitoring. The effects are stronger for
higher ownership levels and firms with weak governance,
less financial distress, longtenured CEOs, multiple
segments, and more free cash flow.
CEO compensation, large institutional ownership, longterm incentive
pay, shortterm incentive pay, small institutional ownership
C33, C36, G32, J33, M12
Over the last 20 years, there has been an increasing trend among institutional investors to
accumulate a large amount of stock. Several studies have examined the potential impact of
increased institutional ownership on various firm policies (e.g., Becker, Cronqvist, & Fahlenbrach,
2011; Chichernea, Petkevich, & Zykaj, 2013; Holderness, 2003; Knyazeva, Knyazeva, & Kostovetsky,
I would like to thank John Doukas (the editor) and two anonymous reviewers for their constructive and insightful
suggestions and comments on this paper. All remaining errors are my own.
2018; Ward, Yin, & Zeng, 2019; Yan & Zhang, 2009). Some papers have analyzed the possible effects
on chief executive officer (CEO) compensation in general (e.g., Clifford & Lindsey, 2016; Cronqvist
& Fahlenbrach, 2009). However, the literature has not reached an agreement yet on whether
institutional investors influence CEO pay (e.g., Zheng, 2010) and, if so, how. It is important to
analyze the relation between managerial remuneration and the ownership by big investors.
Considering their high level of ownership and influence in firms, large institutional shareholders
can shape a CEO's pay structure, which eventually affects the CEO's decisions on firm policies and
various vital operations.
My main research questions expand the literature and focus on the components of CEO
compensation that are associated with large and small institutional ownership and whether
increased ownership by large institutional shareholders influences the CEO pay structure
differently from small institutional shareholders. The literature has overlooked the strong
influence of large institutional shareholders with at least 10% ownership. Therefore, further
research questions in this paper concentrate on whether the results in the literature are driven
by earlier regulatory reforms, as well as by smaller institutional investors.
I focus on firms and investors based in the United States and examine separately how large
and small institutional ownership is associated with different CEO pay components in the
period 20062015. I find that option pay, stock pay, equity pay,
bonus pay, cash pay, and total
pay decrease after large institutional shareholders increase their stakes in these companies.
When small institutional investors own more of these firmsshares, pension, deferred pay, stock
incentive pay, and total longterm incentive compensation drop, although the CEO's salary
remains unaffected. The results indicate that monitoring by large shareholders substitutes for
the current proportion of incentive compensation and CEO total pay, while the longterm
incentive components of pay are affected by small investors. These findings are consistent with
managerial agency theory and the substitution of incentive pay by institutional monitoring.
Jensen and Meckling (1976) note that managerial agency issues can be alleviated by tying the
managersinterests to those of shareholders through incentive compensation. This agency
problem can also be mitigated by strict monitoring. Shleifer and Vishny (1986) suggest that
large institutional shareholders effectively monitor management. Monitoring by institutional
investors can then substitute for the control mechanism through incentive pay.
This paper's extended analyses show that the magnitude of change in CEO pay components
is greater for higher levels of large and small institutional investor ownership. The negative
impact of large and small institutional ownership is more profound in cases in which greater
CEO monitoring is necessary, such as in firms with weak corporate governance, strong financial
security, longtenured CEOs, multiple business segments, and high levels of free cash flow.
In further analyses, I use the total number of large and small institutional shareholders with
stakes in the firm in question as the main explanatory variables. I examine how significantly
the active monitoringclassification can explain changes in CEO pay components compared to
large institutional shareholder taxonomy. I also focus in particular on excess pay and test the
robustness of the findings further in a crosssectional model setup. I acknowledge the difficulty
of finding the perfect instrumentin considering institutional investors (Edmans & Holderness,
2017). Hence, without making any strong claims, I address potential endogeneity issues through
an instrumental variable (IV) regression approach with various instruments that should provide
suggestive evidence only.
The majority of the vesting period for equity compensation is less than 3 years in my sample. Hence, in my analyses, option pay, stock pay, and equity pay can
be categorized as a CEO's current incentive pay.

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